Oil Prices Plunge at the Intersection of Economics and Politics

There has been a rather amazing decline in the price of oil lately.  Crude was as high as $115 a barrel in June, but is now going for $80.  That's an amazing 30% drop in four months.  This has resulted in big drops in the price of gas at the pump.  The nationwide average was as high as $4.11 a gallon in 2008, stood at $3.94 in April of 2012, was at $3.69 this year in June, and now is down to $3.12.  Source US Energy Information Service.   That reduction amounts to 57 cents a gallon in four months, a 15 percent savings so far, with likely more to come as the full drop in the price of crude works its way through the chain.

The first thing to comment on is that this is having a positive economic effect.  Despite price wars over fares, for instance, airlines turned in strong profits in the past six months.  The nine largest U.S. carriers saw their net earnings increase to $3.8 billion compared to $1.6 billion over the same period last year.  The main reason?  Lower fuel costs.  It could spur increased consumer spending too, perhaps for Christmas.  Research shows that every one cent drop in the price of gasoline puts $1 billion into the pockets of the American people.

There are some domestic factors driving the price drop.  Part of it is increased efficiency in gas mileage in the U.S. auto fleet, and the beginnings of a real expansion in renewables, both jump-started by Obama administration policies initiated in 2009.  America uses 1.8 million barrels a day less than it did in 2007.  American production is up too, growing from 5.00 million barrels a day in 2008 to 7.44 million a day at present.  Combine these factors together and the U.S. is importing 4 million fewer barrels of foreign oil a day than it did seven years ago.  That's a foreign exchange improvement of about $12 billion a month, or $144 billion a year--a significant chunk of change, about .8% of GDP, to add to the U.S. economy. 

Just as intriguing are the global forces at work.  In the past, when a global oil glut threatened to erode prices, Saudi Arabia would cut back on its production, making oil scarce and thereby bolstering the price.  This time, however, the Saudis have maintained production and discounted prices to their Asian customers in order to retain market share.  It's very likely there's a geopolitical motive operating here, perhaps even in coordination with the United States.  Sunni Muslim Saudi Arabia is in a real contest for dominance in the Middle East with Shi'ite Muslim Iran.  The major flash point is the Syrian Civil War, in which autocratic President Bashar Assad is being supported by Iran and Russia.  Iran is under international sanctions due to its nuclear program, as Russia is for its recent imperialistic moves in Ukraine.  The Saudis and other Sunni oil states have been supporting the opposition.  But another way to cripple Iran's and Russia's efforts would be to strike a heavy blow against the price of oil.  Russia gets 50% of its budget revenue from oil exports, and Iran gets 60% of its from the same source.

The seriousness of Russia's problem is underscored in a recent article in the Wall Street Journal, which reports, "Russian inflation is at a three year-high, the ruble is trading at new lows, and capital outflows are expected to exceed $100 billion this year. The ruble is under downward pressure both from higher demand for dollars, as companies find it hard to borrow abroad, and from lower oil prices. It has already weakened by more than 20% since the start of the year."  Finance Minister Anton Siluanov publicly warned the Russian Duma (Parliament) that the budget may become untenable.  Expect to see more on this soon.  The economic squeeze on Iran and Russia is not coincidental, and may result in some interesting diplomatic musical chairs in the next few months.  Stay tuned.