Oil prices, cartels, and world economic realignment

ME. Professor, people are wondering if the drop in oil prices will cause a realignment of world economic order? A good time to assess the global economic status is at the start of a new year. World Bank data provide 2013 indicators for 214 nations and territories. The U.S. had the largest economy in 2013 with a Gross Domestic Product (GDP) of $16.8 trillion.  China was second at $9.2 trillion.  Japan was third with $4.9 trillion. Germany, France and United Kingdom were fourth, fifth, and sixth at $3.7, 2.8 and 2.7 trillion, respectively.   At $2.2 trillion Brazil was seventh, followed by Italy at $2.1 trillion. Russia was ninth at $2.1 trillion.  India was tenth at $1.9 trillion. Canada, Australia, Spain, South Korea, and Mexico each ranged $1.8 to $1.2 trillion in GDP and made the next five slots of the top 15 economies.  

BF.  My answer to your question—Yes, there will be realignment. Your data are interesting, but you get a different picture if you measure income per person in terms of GDP per capita. Based current weighted international dollars, you might be surprised to learn the United States ranks tenth at $53,001 per capita. Qatar tops this list at $145,894 per capita. Luxembourg is second at $90,333; followed by Singapore at $78,762; Brunei at $73,823; Kuwait at $70,785; Norway at 64,363; United Arab Emirates at $63,181; and Switzerland at $53,977. The next five slots in the top 15 include Hong Kong, Saudi Arabia, Bahrain, the Netherlands, and Australia. There are more oil producing nations on the GDP per capita list of top ranking nations. 

ME.  Economic implications for 2015 from the recent global oil price drop become a little clearer by comparing the two lists.  Russia was among the top ten in economy size, but it ranked 46^th in GDP per capita at $24,298 per person.  Qatar was first on the 2013 income per capita list, but it ranked 51^st in terms economic size as measured by GDP at $.203 trillion. Brunei was 3^rd on the top ten income list, but ranked 113^th in economic size.  Saudi Arabia was on the top ten income list and it also had the largest Middle-eastern economy, as it ranked 19^th with a $.748 trillion GDP. The United Arab Emirates was also on the top income list and it ranked 29^thwith a $.402 trillion GDP. Oil revenues made a difference, particularly in income per capita rankings. 

BF.  Vladimir Putin faces a double whammy in 2015.  Western embargoes over Russian encroachment into Ukraine have impacted the Russian economy along with the drop in crude oil prices.  In 2013 according to the U.S. Energy Information Agency, oil and gas generated more than $350 billion in Russian exports.  If $122 billion in domestic sales are added to its exports, oil and gas accounted for $472 billion or more than 22 percent of the Russian economy.  Putin is one who likes to be in control of his nation’s affairs.  However, Russia was rebuffed for NATO membership by the West a few years ago and Russia is not a member of Organization of the Petroleum Exporting Countries (OPEC).  So, Putin is currently more on the receiving end of global economic woes.  Still Russia has the eighth largest proven oil reserves and with its military strength, international relations and national security risks cannot be ignored.   

ME. That brings up questions about whether OPEC still in control of global oil markets.  Are we seeing the demise of OPEC or is it a short term glut and shakeout?   My notes from your class say that cartels are difficult to sustain longer term.  One reason a cartel worked longer for OPEC is that oil is regarded as a finite nonrenewable resource and oil production has an inelastic demand in the short run.  So when a cartel cuts production by 10 percent, prices increase more dramatically than the production cuts and the cartel extracts greater monopolistic rents or excessive revenue margins above the cost of production. However if prices remain high long term, people adjust, consumers become conservation-minded and gas mileage efficiency rises. Countries outside of the cartel expand oil and gas exploration and drill new wells. New fracking and horizontal drilling technologies develop, renewable biofuels emerge, and alternatives sources of energy such as wind power, solar energy, renewable gas, and electric cars develop.   

BF.  I argue OPEC is in its last chapter. The Organization of the Petroleum Exporting Countries (OPEC) was founded in 1960 by five countries: Iran, Iraq, Kuwait, Saudi Arabia and Venezuela.  By 1975,Qatar, Indonesia, Libya, the United Arab Emirates, Algeria, Nigeria, Ecuador, and Gabon joined.  Ecuador suspended its membership from 1992 to 2007.  Gabon terminated its membership in 1995.Angola joined in 2007. Indonesia suspended its membership in 2009.  OPEC currently has only 12 members.  OPEC members do make up eight of ten nations with the largest proven oil reserves. But Canada and Russia are two others with top ten reserves and new reserves have been added during the past decade.  The U.S., China, Brazil, Mexico, and India have reserves ranked between 11th and 20th.  If OPEC restricts production, other non OPEC members potentially fill the gap and reduce cartel market share and margins.  

ME.  I say we are seeing an oil glut and shake-out, instead of the last chapter. As global oil prices fall by half, oil and gas production sectors experience reduced economic outlooks globally. Petroleum represents the dominant export commodity and main source of income for OPEC members.  The economies of most OPEC nations are 50 to 80 percent dependent on oil and gas production related sectors for GDP.  While some OPEC members like Saudi Arabia, Qatar, and United Arab Emirates have accumulated wealth and are able to outlast lower oil prices for a long period of time, consequences for other OPEC members like Venezuela, Libya,Nigeria, Algeria, Ecuador, Iraq and Iran will appear sooner as they have less accumulated wealth.  Cartels are not organized to lower prices as monopoly rents are lost in the process.

BF.  Energy consuming nations and sectors that are net users of energy will experience more rapid economic growth from lower crude oil prices. The United States and other diversified economies will be stimulated by lower petroleum prices.  Food consumers will benefit from the energy input side of the food and agriculture supply chain. If crude oil prices are sustained at $50 per barrel level instead of $100 per barrel, several things will occur. More energy consumption by consumers will occur. Economic incentives for oil exploration and well drilling are reduced. Oil production drops from areas exceeding $50 per barrel in production costs. Rewards decline for developing new technologies or for switching to alternative energy sources.    

ME.  The bottom line depends on whether the drop in crude prices are temporary or longer term. Overall the global economy will be stimulated from lower crude prices. Unresolved however is the net crude oil price drop impacts on global income inequality.  National security risks may emerge if dependence on imported oil rises again.  Some higher cost oil patch developments, alternative energy sectors, and related emerging energy infrastructure networks may go into remission unless sustained by policy decisions. Greenhouse gas (GHG) emissions will likely increase from higher gasoline consumption and add to the climate change debate.

*  Edelman is a professor of economics at Iowa State University and Flinchbaugh is an emeritus professor of agricultural economics at Kansas  State University.