The main aim of the essay is to discuss the scenario of oil and gas industries in Saudi Arabia. The author in this essay discusses the prices of the oil and its impact on the economy as well as oil market. The prices of oil were continually increasing due to various reasons such as high demand, low supply, black-marketing by the OPEC countries and scarcity of natural resources. In 2014, the prices of oil collapsed. The main reason was the non cooperation of Saudi Arabia with other OPEC countries. The essay illustrates and discusses the reasons for the fall in the prices of oil and its both long term and short term impact on economy and oil market. The author also discusses the strategies adopted by Saudi Arabia. The survey shows that Saudi Arabia is not being able to influence the market due to small market share (Singleton 2013).
The paper discusses the factors and actors of collapse of oil prices and its consequences on the economy. There are various reasons for the fall in the sudden prices of oil. The entire market structure changed due to changes in the prices of oil. The research shows that Saudi Arabia will not be able to win the oil price war is due to the market that it has. The impact of the collapse in oil prices is directly on the jobs and capital expenditure. The paper discusses the investments in new exploration and production projects. The price of oil barrels has reduced to half in less than a year (Arouri and Rault 2012). The countries and the industries that were benefiting from the high price of oil are now facing loss. The companies that were making profit in past years are now cutting the investments in exploration and production of crude oil.
Important factors affecting oil price collapse
There were mainly four factors that contributed towards the collapse of oil prices. The main reason for collapse of oil prices was changes in the structure and planning of Saudi Arabia in the supply of oil. The reasons for fall in oil prices are explained as follows:
Oversupply of oil
If the supply of a product is higher than the demand, the price of the product falls in market as there is very less people to purchase the commodity. The suppliers have to reduce the price in order to sell its produce (Baffes et al. 2015). Hence, the price falls. This can be shown in a demand and supply framework as follows:
Figure: Market equilibrium for crude oil
(Source: Created by author)
The above diagram shows that the equilibrium supply is S0. The equilibrium is E0 and the equilibrium price and quantity is P0 and Q0. As the supply of the product increases, the supply curve shifts to its right to S1. Since the demand for the product is same, the price of the product falls to P1 and the quantity increases to Q1. Hence, the above diagram shows how an increase in supply can lead to a fall in price. The total production of crude oil is expected to rise to over 9.35 million barrels per day that is higher than the forecasted production. The piling of stocks of crude oil or oil inventories is increasing day by day. The survey showed that the U.S. commercial crude oils inventories rose by 4.5 million barrels from the previous year. This was the major factor in the decline of prices of crude oil (Basher et al. 2012).
Ineffectiveness of OPEC Countries
Organization of petroleum exporting countries (OPEC) is a cartel of oil producers that greatly affects the activities of crude oils and its prices. The unwillingness of OPEC countries to cut the production of crude oils was another reason for the fall in the prices o crude oil. The prices of crude oil fell by fifty percent since the decision of organization to cut down the production of crude oils. Venezuela and Algeria the two participating countries of OPEC decided to cut the production to boost the prices of crude oil. Saudi Arabia and United Arab Emirates, the other two participating countries of OPEC refused to cut down the production (Bowler 2015). This led to the increase in the production of crude oil that put a downward pressure on the prices of crude oils for the long term.
Strong U.S. Dollar
The other reason for fall in prices of oil is strong value of American dollar. The value of American dollar is higher than Euro that leads to appreciation of the exchange rate and fall in the prices of crude oil. Strong value of dollars indicate fall in the value of commodities. The prices of global commodity are expressed in terms of exchange rate and a strong value of dollar has a great impact on the prices of crude oil (Dev 2016). This can be shown in a diagram below:
Figure: Appreciation of national currency causes fall in net exports and leads to decline in the price level
(Source: Created by author)
Decline in demand
Decline in demand for crude oils is another reason for fall in the prices of crude oil. The main reason for decline in demand is weakening of the economies of Europe and other developing countries. The vehicles that are produced recently are fuel efficient that requires less fuel in its operation. This is also one of the reasons for the fall in the prices. The supply of oil is continually increasing and the demand is falling that is leading the prices of the oil to fall. China is the world’s largest importer of oil. Devaluation of the currency of china is one of the major factors for the decline in demand of crude oils (Arezki and Blanchard 2014). This can be expressed in a diagram as follows:
Figure: Demand supply framework to describe fall in oil prices
(Source: created by author)
As the demand falls the demand curve shifts to its left. The supply remains the same and hence the price falls from P1 to P2. Hence low demand leads to fall in prices.
Iran nuclear deal- Iran nuclear deal is an agreement between Iran and other nuclear countries. The primary motive of the agreement is to reduce the facilities of nuclear activities. The deal removes the restrictions of the western economies to export crude oil that increases the supply of crude oil and decreases the price (Baumeister and Peersman 2013).
The prices of crude oil are expected to fall further because of the overproduction of oils by OPEC countries, slowdown of the economy of china and European Union and rise in US shale oil production. Then major factor behind the steep decline in the prices of crude oil was the collusion between Saudi Arabia and United States whose main aim was to reduce the revenues of Iran and Russia (Kilian 2014).
Figure: Falling crude oil prices
(Source: Samargandi et al. 2014).
Short and midterm impact on the oil market
Changes in prices of oil is having both long and short term impact on the economy and market for oil. Cut in the oil prices is only beneficial for short term. In long term the economy will face a severe oil crisis due to continuous fall in prices of crude oil. The fall in prices of crude oil is not likely to fall for a long period of time as fall in prices affects the major players of the economy. The main players that is affected due to fall in prices of oil are global investments, oil producing industries and oil producing countries (Griffin and Teece 2016). The global investments and projects of energy sector dropped down by hundred billion dollars due to fall in the prices of oil. Fall in the investments is one of the major impacts of fall in crude oil prices.
The second major impact was on the oil industries that are famous globally such as Royal Dutch Shell, Statoil and Chevron. The profits of the major industries declined and also its capacity to investment in new projects. This further led to the decline in the growth of the economy. The loss of all the major companies accounts to 1.3 trillion dollars that combines all the market capitalization of the companies (Nakov and Nu?o 2013).
The revenues of the oil suppliers are decreasing due to which the unemployment is also increasing. The main impact of fall in prices of oil is on Russia as it is the world’s largest oil producing country. Revenue from exporting energy is main source of capital inflow in the Russia. Decreasing oil prices has reduced the revenues of the export sector of the country. Therefore, it has affected the GDP of the country. It not only affects the economy of Russia but other countries as well such as Saudi Arabia and Venezuela as they are the major importers and exporters of oil. The fall in the prices of oil does not only have a negative impact but also has a positive impact. The demand for the complement goods such as cars rises in the market (Rautava 2013).
Figure: Investments and exploration by oil industries
(Source: Kaletsky 2015)
Fall in prices of crude oil benefits the oil suppliers and manufacturers only in short run. Low oil prices helps in reducing the cost of manufacturing. Low prices reduce the global investments that put an obligation on the companies to reduce its spending. This makes thousands of people redundant and jobless. The importers are in advantage while the exports face loss due to fall in the prices of crude oil (Rautava 2013). The major oil importers such as China, United States and India benefit as they are able to import the oil at low prices. At the end if the fall in the oil price continue then no winners are left. The economy and industries only loose.
The prices of Indian Crude oil prices have fallen by fifty seven percent. The fall in the prices of crude oil has not only affected the refining industries in India but also the upstream oil and gas industry in the economy as a whole. The sustained fall in prices of crude oil is beneficial for the Indian economy (Platts.com. 2016). Since India is the major importer of oil fall in the price of crude oil will benefit the economy and derivatives of oil suppliers. The country will be able to save on its imports and even the oil derivatives will benefit such as auto, paint, oil, and aviation industries.
The input costs or the costs of productions will also fall for the oil derivative companies as the raw materials is available at lower prices. India is one of the major importers of oil and its accounts for eighty percent of total oil consumption. The current account deficit is narrowed due to decrease in the value of imports. Oil prices affect the prices of other complement goods as well. As the price of crude oil falls the overall prices of goods and services also fall in the economy (Reboredo et al. 2016).
Fall in the prices of crude oil led to the rise in the budget deficit of Saudi Arabia. The budget deficit accounted for twenty percent of the nations GDP. The consequence of the rise in budget deficit is that Saudi Arabian countries have started investing in new projects and resources other than oil. The suggestion of the government is to cut the future spending on production and exploration by twenty five percent to balance the budget and reduce the deficit. The debt of the countries is rising due to lower profits that the country is generating (Kilian and Murphy 2014). The revenue of the Gulf oil producers fell by twenty one percent. The major revenue generation of the country depends on the on the oil export revenues. CAPEX is capital expenditure that is the money that is invested by a firm to acquire and upgrade fixed and physical assets such as buildings and equipment for a new business or project.
Figure: impact of fall in oil prices on Gulf producers
(Source: Forbes.com. 2016)
Impact of fall in oil price on country depends on trade pattern of the country. The countries, which has larger share in oil import are benefitted from fall in oil price. Fall in oil price improves the terms of trade of the oil importing countries in short run. On the other hand, the income of net oil exporters decreases due to fall in oil price. Moreover, decline in oil price reduces the cost of production of business due to fall in transportation costs. Fall in production cost influences product price to fall in medium term.
Reasons of Saudi Arabia’s inactiveness in the market
The main strategy of Saudi Arabia was to gain the major market share by supplying the oil at lesser price. Saudi Arabia refused to follow the strategy set by OPEC countries. The strategy of OPEC was to share the production with its member countries that was motivated by Iraq and Iran’s demand for larger quotas to hold future production (Blanchard and Riggi 2013). The policy of cutting down the prices would mean cutting down the production of crude oil. This would lead the OPEC countries to lose the major market share and its rivals gain the benefit.
Iran and Iraq are the main political rivals of Saudi Arabia and hence it will not take any actions that will benefit its rivals. Cut in the prices of oil and cut in the production will benefit the rivals which Saudi Arabia will never follow. Then unity of the OPEC countries is getting hampered due to the disapproval of rules and policies set by the organization. In order to avoid further problems Saudi Arabia should follow the policies set by the OPEC organization (Next.ft.com 2016). Moreover, it has been argued by some market analysts that Saudi Arabia has enough reserve of money to spend in the economy. Therefore, decrease in oil price would not affect the country much. It has less incentive to influence oil price. The main motive of Saudi Arabia is capturing oil market. In order to do this country has let the oil price to fall below marginal level to move out potential competitors from the market. Less competitors in the market might help the country to acquire more market share in long run.
Saudi Arabia is a cartel of oil producers. The OPEC countries had decided to cut the production by fifty percent. Saudi Arabia did not agree to it and indulged in oversupplying the product due to which the price for oil rose. The main reason for Saudi Arabia not influencing the market is its small market share. Fall in prices led many new strategies such as CAPEX cuts by IOCs. The countries are engaging in producing more efficient product so that it has less emission of carbon dioxide (Griffin and Teece 2016). It’s not only Saudi Arabia that contributes in large [production of oil to OPEC countries but Iraq is the largest producer of oil.
International oil companies share the same vision with Iraq’s policy to contract the effect and impact of the changes in the oil process on the economy. IOC has signed a deal to recommend the changes in the deals regarding the technical services. The main concern of IOC is on Iraq’s policy of overproduction of oil. The main aim of the International oil companies is to keep the costs down where the profit generated from oil production will represent the price of the crude oils in the production sharing contracts (Alshehry and Belloumi 2015).
Oil and Natural gas Corporation has decided not to cut CAPEX despite of the fall in the prices of crude oil. The CAPEX activities will result to a fall in the financial services and costs of providing oil. Various oil projects have been cancelled due to fall in the prices of crude oil. Due to cancellation of projects many people have been left jobless across the globe especially in the Gulf courtiers (Kilian and Lee 2014).
It is essential for the government of Gulf countries to reduce the unnecessary expenditure in order to cope up with the decline in revenue that is arising due to fall in the prices of crude oil. Excess usage of oil leads to changes in climate that ultimately causes global warming hampering the environment. People are becoming aware of the environment that is pollution free and healthy (Alkhathlan and Javid 2013). Hence, electric vehicles have been developed that reduces the amount of oil consumption. Experts predict the prices of oil to fall further in future to an ever diminishing supply of oil. The main factor that will help in reducing the price of oil is low production of oil by the OPEC countries especially Iran and Saudi Arabia. It is essential to boost the market of China and Europe in order to increase the demand of oil. The invention of shale oil in United States has contributed to a low demand of oil in OPEC countries (Turhan et al. 2013).
Rise or fall in price of one product influence the whole economy. Saudi Arabia is a key player in oil market. The main reason for the collapse of prices was the strategies adopted by Saudi Arabia. The collapse of price led to change in the marketing strategy of many countries and industries. Continuation of fall in prices of crude oil will damage the global economy as a whole specially to the oil producing industries and the countries engaged in import and export of oil. There were several factors that led the prices of crude oil to collapse. The main reason was the non- cooperation of the Saudi Arabia with OPEC countries and its policies. Fall in prices of crude oil has a long term negative impact on the global economy. The fall in the prices of crude oil has largely affected the Gulf oil nations as the revenue of these countries depends on the exports of oil.
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