Since mid-2014, oil prices have fallen by 75%. This has been a hard hit to many oil-reliant economies, especially Russia’s, with 70% of their export incomes coming from oil and gas. From 2010 until mid-2014, world oil prices had remained pretty stable, at around $110 a barrel. But since June 2015, prices have more than halved. Prices touched $28 a barrel in February 2016, and have now begun to recover slightly. But how could a price rout happen so fast? It all boils down to the economics of supply and demand.
The growth of oil production in North America has been staggering, with US oil production levels at their highest in almost 30 years. Fracking has been one of the main drivers of lower oil prices because this has increased the world supply of oil and created spare supply; oil that was once sold in the US is suddenly competing for Asian markets, and the producers are forced to drop prices. Furthermore, the oil cartel OPEC, the Organisation of the Petroleum Exporting Countries, is determined not to cut production in an attempt to prop up prices. This has caused prices of OPEC’s benchmark crude oil to fall 50% since the organisation decided against cutting production at a 2014 meeting.
Saudi Arabia’s oil minister, Ali al-Naimi, said that “it is not in the interest of OPEC producers to cut their production, whatever the price is." This has been a deliberate move by the Saudis to try and drive the Americans out of the oil market. By supplying so much oil at incredibly low prices, the Saudis are in effect trying to make it uneconomical for the Americans to produce oil as the Americans will not make enough profit to make it worth staying in the market. Therefore in the long run, the Saudis will have greater control over the oil market and generate greater revenue if they keep supplying at such low prices now.
Oil prices have also submerged because of the slowing global economy, especially China’s economy, which has just experienced its slowest growth in a quarter of a century. With China being the world’s largest oil importer, this is a huge hit to global demand. This, combined with the fact that vehicles are also becoming more efficient and people are opting for more eco-friendly alternative cars, causing the demand for fuel to fall, has contributed to the drop in oil prices. So what does this all mean for Russia?
Moscow’s budget for 2016, which predicted oil would cost twice as much, is deeply in the red. In response to the lower oil prices, earlier this year, Russian Finance Minister Anton Siluanov said that the exceptionally low price for oil meant a further reduction in revenues for his country’s budget, leading to an expected deficit of $38.6 billion for Russia in the coming fiscal year. The pressure on the budget is forcing Moscow to expand its austerity programme which will see reductions in spending for virtually all government activities outside the military and social services. The finance minister said that Russia had been relying on the country’s Reserve Fund, one of its sources of sovereign wealth, to make up some of the budget shortfall. But in December 2015 the fund lost 16% of its value, and the finance minister said that it may run out of money altogether by the end of 2016 if the government doesn’t take action. On top of this, the war in Syria is taking a hefty chunk out of Russia’s wallet, and the announced increases in military spending are not likely to be reversed.
So where do the ordinary Russian people stand in all of this? Those who want to travel abroad have had to scale back as the diminishing rate of the rouble has made the cost of visiting foreign cities very expensive. Rising food prices have also made it harder for individual families to balance the books. Falling oil prices were one of the principal reasons for the collapse in the Soviet economy, and some economists have warned of history repeating itself.
Original Illustration by Alex Nutman