Oil Prices Are Dropping. So What?

Wednesday, November 12, 2014

In Politico Magazine, Gal Luft had this to say about our currently dropping oil prices:

Ten years ago, when oil prices were under $40 a barrel, the idea of $80 oil considered “cheap” would have sounded inconceivable. But let’s not be mistaken: Oil is not cheap even at its new level. It costs the Saudis and their OPEC partners under $5 to produce a barrel so their profit margins are orders of magnitude higher than in any other commodity. In fact, on an energy-equivalent basis the new “cheap” oil is still four times more expensive than coal and natural gas.

While the other fossils compete with each other — as well as with nuclear, solar, hydro and wind power — over market share in the electricity generation sector, oil faces no competition in the sector that matters most for the global economy: transportation. This monopolistic position has allowed OPEC, a cartel that today produces fewer barrels than it did 40 years ago despite controlling more than three-quarters of the world’s conventional reserves, to hike the price gradually in order to meet its member regimes’ budgetary needs. And those needs are only going to rise.

Advice to Washington: Don’t get too comfortable with the new price level, as it is not reflective of a new era of cheap oil but merely a remission in the global economy’s worst affliction: oil’s virtual monopoly over transportation fuels. While OPEC, for tactical reasons, might keep its production level intact over the next few months, it is not likely to do so for very long. Most of its members need higher prices to balance their budgets: Saudi Arabia needs $95 per barrel; Venezuela $120; Iran $140. For these countries, the only possible course of action to avoid economic collapse is to cut production in order to offset the rising supply of North American oil. In other words: higher prices, again. Sinking into complacency and veering off the worthy goal of opening the transportation sector to fuel competition would sow the seeds for a painful oil shock down the road.

Gal Luft is co-director of the Institute for the Analysis of Global Security and senior adviser to the U.S. Energy Security Council.

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