How do international relations affect oil prices?

Energy policy

Leon Leschus

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Leon Leschus studied business administration and economics in Rome and Münster. Since May 2006 he has been a research assistant at the Hamburg Institute of International Economics (HWWI), where he is responsible for raw materials and the HWWI raw material price index. Since October 2010 he has also been a member of the AIECE working group for raw materials.

The oil price is subject to considerable fluctuations. The reasons for this are economic cycles, natural disasters, wars and speculation, but also political interventions such as subsidies or the release of strategic oil reserves.

Statoil oil rig in the Norwegian North Sea. (& copy picture-alliance / AP, Statoil)

The global economic development has a strong influence on the demand for oil and accordingly on the oil price. The International Energy Agency estimates that in 2012 a total of around 90 million barrels (equivalent to 159 liters) were consumed per day. The largest oil consumers worldwide are the USA with around 19 million barrels per day, Europe is around 13.5 million barrels and China is a good 9.5 million barrels. The demand for oil from China in particular has risen sharply in recent years. It has more than doubled since the turn of the millennium. Due to the increased prosperity, more and more people want to be mobile and drive cars there too.

Subsidies distort the oil price

Global oil consumption has grown steadily since 2000, only interrupted by the economic and financial crisis of 2008/09. As a result, the price of crude oil has risen internationally. However, the price of crude oil and gasoline is kept artificially low in some countries. This is the case in China, but also in oil-producing countries such as Saudi Arabia and Iran. Government subsidies do not make the actual scarcity of the energy source oil clear to the consumer, which means that resources are wasted. Consumers have become used to the subsidies, as demonstrated by violent demonstrations in Nigeria in early 2012 when subsidies on gasoline were about to be lifted.

According to the International Energy Agency, international oil demand could fall by almost 4 million barrels a day by 2020 if all subsidies on fossil fuel consumption were abolished worldwide. A decline in oil demand would, in turn, reduce prices. The two oil crises in the 1970s in particular showed that higher energy prices lead to consumer adaptive reactions. Since then, oil intensity, i.e. oil consumption per unit of gross domestic product, has decreased by around 50 percent in the industrialized countries. More energy-saving machines were used and houses were better insulated.

Wars and unrest in oil states lead to drastic price increases

In addition to demand, supply also influences the price of oil. Political unrest and tensions in important oil-producing countries immediately lead to sometimes drastic price increases. In spring 2011, the price rose to over US $ 125 per barrel when armed conflict began in Libya and oil production of 1.6 million barrels per day came to a complete standstill. At the beginning of 2012, tensions between Iran and Western countries over the Iranian nuclear program caused the oil price to rise sharply. Market observers worried that Iran could block the sea route from Hormuz, through which a considerable part of the internationally traded oil is transported at around 16 million barrels a day.

OPEC serves a third of the world's oil demand

In addition to political conflicts in oil-producing countries, the production policy of the OPEC countries also influences the oil price. In 1960, 5 countries - Iraq, Iran, Kuwait, Saudi Arabia and Venezuela - founded the OPEC (Organization of the Petroleum Exporting Countries) to coordinate the common oil supply. The OPEC currently has 12 members, who with a good 30 million barrels a day currently serve around a third of the oil demand. Too low an oil price is not in the interests of OPEC members, as they finance a considerable part of their government spending from oil revenues. Saudi Arabia, the largest OPEC oil producing country with currently around 10 million barrels per day, needs an oil price of approximately 100 US dollars per barrel for its national budget. In the course of the Arab Spring, the Saudi royal family had increased government spending sharply in order to appease the people striving for reform with welfare programs. However, too high an oil price is not in the interests of the OPEC countries either, because it could negatively affect the global economy and thus significantly reduce oil demand. In order to be less dependent on the production policy of the OPEC countries, the industrialized countries are building strategic oil reserves. However, these should only be used in crisis situations (wars, natural disasters). In the summer of 2011 they decided to release part of these reserves in the wake of the Libya crisis in order to lower the oil price. An additional 2 million barrels a day were brought onto the oil market for one month. This had only happened twice before: during the first Iraq war and during Hurricane Katrina in the Gulf of Mexico. However, the lowering effect on the oil price in 2011 was only temporary. This is understandable, since the additional 2 million barrels of oil a day does not even represent two percent of global demand. The release of strategic oil reserves therefore only has a limited effect.

Regional conditions influence the oil price

On the supply side, regional differences can lead to different oil prices. The price of WTI (West Texas Intermediate) oil is currently a good 23 US dollars lower than that of Brent oil. The oil supply in the American Midwest is central to the formation of the WTI price. In Cushing, the local transshipment point for oil, the oil stores are very well filled. This is mainly due to the large amount of additional oil from Canada that is pipeline into the US Midwest. In Canada, oil sands and shale are increasingly being extracted, but this is also happening increasingly in the US states of North Dakota, Oklahoma and Texas. The large oil supply cannot be mined in the American Midwest due to a lack of infrastructure to transport the oil to the Gulf of Mexico. From there it could be shipped internationally.

The situation with Brent oil, however, is completely different. Brent oil in the North Sea is mainly produced by Norway and Great Britain. however, oil production there has been declining in recent years. Since 1996, oil production in the North Sea has decreased by around 50 percent. Repair measures on the production systems also repeatedly lead to price increases for Brent oil. The price of Brent oil is an important benchmark for determining the price of other types of oil. Around two thirds of the crude oil traded worldwide depends on the price of Brent. The declining production in the North Sea intensifies the discussion as to whether other types of oil, such as the Russian Urals oil, should not be included in the Brent oil. The less and scarcer the Brent oil becomes, the more susceptible it is to sharp price shifts if a production system fails or oil is held back from the market through manipulation.

State oil companies are gaining influence

In many regions of the world state corporations have taken control of their own oil reserves, for example Saudi Aramco in Saudi Arabia, Petrobrasin Brazil, Petróleos de Venezuela S.A. in Venezuela or Rosneftin Russia. The wealth of some sovereign wealth funds has increased enormously as a result of the oil revenues. For example, the Abu Dhabi Investment Authority (ADIA) sovereign wealth fund is believed to have an estimated $ 627 billion at its disposal. Until the beginning of the 1970s, the private mineral oil companies were still exploiting the oil fields on their own. Now, however, they sometimes only have the role of a smaller partner who brings the technical knowledge into a cooperation with a state-owned company. This usually has the funding rights. The private oil companies are therefore increasingly specializing in oil wells that are difficult to develop because they are among other things. located in deep waters. Their development is associated with high costs and risks, as was the case with the disaster in the Gulf of Mexico in 2010.

Speculation drives the price

The oil price reacts to changes in supply and demand, and speculation on the stock exchanges also influences price developments. A great deal of additional capital has been swept into the oil market in recent years. Many investors used commodities and especially oil as tangible assets to hedge against inflation and to diversify their stock holdings. Investors' fears of inflation were heightened by the monetary policy of central banks such as the European Central Bank and the US Federal Reserve System. In order to support the global economy, interest rates were lowered very sharply, which provided the financial markets with a lot of liquidity. Interest rates in the US are currently particularly low, which, in conjunction with high US national debt, is putting the US currency under pressure. A weaker US dollar, in turn, increases the price of oil because oil is traded internationally in the US currency and investors in foreign currencies use the devaluation of the dollar to buy cheaper oil.

In order to avoid excessive price movements and curb price excesses, the American regulators decided to make the raw material markets more transparent. Since 2006 it has to be disclosed who is investing in the crude oil market. A distinction is made between market players who are actually interested in physical oil, such as airlines or chemical companies, and those who are likely to only speculate on price movements. The former are classified under "Commercials" and the latter under "Non-Commercials". Price movements can be limited using various position limits for the individual players. In general, however, it is very difficult to distinguish whether a bank is doing a speculative transaction or acting on behalf of a customer who wants to hedge against excessive price fluctuations in oil.

Derivatives market and spot market

The futures market determines how much oil will cost to be delivered at a certain point in time, for example in three months. In contrast, on the spot market, the prices for short-term oil deliveries are set within a few days. Most of the time, market players are active here who want to compensate for short-term under- or over-coverage with oil. The greater part of the oil business, on the other hand, is handled through long-term contracts. If the oil prices on the spot market are higher than the oil price on the futures market, this indicates that the oil market is currently tight. In technical jargon, this market constellation is called "backwardation". If, on the other hand, the oil prices are more expensive for longer-term transactions, this is called "contango". The prices for the crude oil are also set by price agencies. Several times a day, you can find out from global oil traders, oil companies and bulk buyers how up-to-date the demand and supply situation is on the relevant marketplace.

Incentives for biofuels are increasing

Strongly fluctuating oil prices are also to be expected in the future. Too many factors have an impact on pricing. The global economy will play an important role. China's economy is currently growing a little more slowly, Europe is facing a euro crisis and the USA is struggling with high national debt. This dampens the demand for oil. If the world economy improves, demand will then increase again.

As far as the oil supply is concerned, oil production will continue to decline in some important regions in the future, which will then have an effect on the price of the oil in question. Declining production is forecast for Brent oil in particular. In general, it can be assumed that the easily accessible oil fields will be used up more and more. This will bring the focus to the extraction of unconventional oil deposits such as tar sands and oil shale, of which larger quantities are stored in Canada and Venezuela. Developing these deposits, however, is expensive and only pays off above a certain oil price. For example, oil sands in Canada would not be profitable below an oil price of US $ 60. The costs of deep-sea extraction are also comparatively high. Higher production costs are likely to increase the price of oil. It is to be expected that the importance of OPEC will continue to grow in the next few years. Libya, but above all Iraq, succeeds in expanding oil production. However, the Middle East is precisely a region marked by political instability. If unrest occurs there, the oil price can rise sharply in a very short time and, in addition, call speculators on the stock exchanges to the scene. In the long term, rising oil and gasoline prices mean that oil is replaced, e.g. by natural gas, biofuels or electric drives.