The Cartel, Coronavirus, and Combustibles
The effects of pandemic concerns on the global economy spread just as fast as the virus itself. As the impact and the severity of the virus was realized, global markets responded accordingly. In less than the span of a month, U.S. markets dropped around 30%. The recent economic decline can be attributed to a number of factors stemming from the coronavirus, such as public uncertainty about the strength of the market, or recession fears, but the most direct and measurable cause to its decline is the price of oil. The largest and most significant market drop was the change in the value of oil which plummeted around 60%, the largest fall this century. In just one day, the price of oil fell nearly 25%, depleting the value of Earth’s oil reserves by $20 Trillion, or just over $2,500 per person globally.
The omnipresence of oil within the global economy affects everyone’s day-to-day living such as how people get to work, how food is processed, and how goods are delivered. On a larger scale, oil is contentious for the dependence it creates on hostile, energy rich nations, and the magnitude it has on climate change.
Additionally, oil is unlike other commodities. Hot dog buns, umbrellas, and shoelaces are all sold in a free market. Oil is not. In order to understand how this quasi-monopoly originated, one must go back to 1960s Baghdad when a band of countries with a plethora of oil reserves, asked themselves the fundamental question: why are we competing against each other and driving oil prices down when we can limit production and sell at a higher price?
The answer to this question was the formation of a cartel known as the Organization of the Petroleum Exporting Countries, or OPEC. A cartel is an association of manufacturers within a specific industry that coordinate production with the intention of driving up prices. This practice, although very prevalent in America during its early years, no longer exists because it is highly illegal. The reason the OPEC cartel can exist is because these countries are not bound to American law. In fact, most of the countries within OPEC are largely located in the Middle East and Africa and have a government-controlled oil market. This powerful stronghold on the global supply of oil allowed once economically negligible countries to become overnight global powerhouses. With no end in sight to the cartel’s rein, OPEC kept on pumping oil at their controlled rate with no real challengers to their stronghold.
That was all until about a decade ago, however the advent of fracking allowed the U.S to earn the title of the world’s largest oil producer. The new contenders in this rapidly changing market dented OPEC’s market control over oil and transitioned a once heavily cartel-controlled commodity into a freer market. OPEC, bruised and battered, looked for one final hail mary pass to reinvigorate their cartel, and it was none other than Russia that agreed to be inducted as the newest member. Russia is a massive player in the production of oil, with nearly half of its national budget coming from oil and gas revenue and producing the third most amount of oil only behind the U.S. and Saudi Arabia. Russia, and 9 other non-OPEC nations joined OPEC to form the aptly coined “OPEC+” or the “Vienna Group.” This increased the supercartel’s control of global oil supplies from 35% to 55%. In November of 2016, OPEC signed an agreement with its then non-member nations to limit oil production, causing prices to increase over 40% until May of 2018.
The agreement signified OPEC+’s victorious rebound, and as long as there was production coordination among the 24 countries, OPEC+ would forever cement its tight grasp on the world economy of oil. Most economists saw the day of OPEC+’s fall and the day the world runs out of oil as one in the same, but nobody could’ve predicted OPEC+’s inner turmoil that may have changed the fate of oil forever.
China imposed strict quarantine policies which limited travel and shut down businesses – effectively stopping the flow of oil to the world's largest oil importer. As other countries soon followed their own form of China’s disease prevention policies, the global demand for oil further decreased more than it had during the 2008 financial crisis, and prices began to fall.
This issue strikes OPEC at its core and led to an emergency meeting in Vienna with the original 14 countries. Their objective was simple: cut back oil production by 1.5 million barrels per day until the end of this year in order to stabilize prices. Shortly after the initial proposition the plan was proposed to the newly recruited 10 countries, but most importantly Russia. The meeting did not go as smoothly as the previous day’s plan, with delays and hostility from the Russian envoy. The pent-up aggravation eventually blew up with the Russian Energy Minister Alexander Novak walking out of the meeting and telling the OPEC+ countries to “…Pump at will.”
A successful cartel is built on two principals, as many countries as possible (a large market share) and the discipline to curtail production. As Novak walked out of that meeting, both these conditions followed. In the following days the two most influential countries of OPEC+, Russia and Saudi Arabia, now competitors, followed Novak’s advice and ramped up production in a market that was already experiencing diminishing demands. This caused the price of oil to nosedive more than it already had, marking it as the largest fall in oil prices in this century.
Luckily, the economic implications of this fall in oil prices will most likely have no long term effects. When the coronavirus subsides, restrictions to businesses and travel will be lifted, the demand of oil will return and prices will rise. As for the short-term economic effects, consumers of oil, such as factories, travelers, and China will all benefit from the low price of oil. If this were to happen a decade ago, prior to the introduction of fracking, low oil prices would have been a valuable economic stimulus for the U.S. It is important to mention that this price change isn’t entirely bad for the U.S., because consumers of oil will still benefit as they would have before the U.S. became a global player in the oil industry. However, now that the U.S. is the world’s largest oil producer, all the oil producing states will take a significant hit. People that rely on the tax dollars from oil to build schools or roads, the oil businesses themselves and related businesses will be impacted severely.
Many U.S. oil companies, especially small businesses, took out loans to get a piece of the rapidly growing U.S. fracking market, which means that many of the companies producing oil within the U.S. are operating while in debt. If the price of oil goes down enough to push profits into the red, companies that already owe money will not be able to operate at a loss even in the short run. Many jobs may be lost, with layoffs already ramping up and James Bullard, the President Federal Reserve Bank of St. Louis, predicted that the U.S. unemployment rate may hit 30%.
The geopolitical effects of the coronavirus which began in Wuhan, lead to the indecision of the world’s most powerful cartel in Vienna and affects mom and pop oil businesses in Texas. This complex pattern of dominoes demonstrates just how intertwined oil is with our everyday living and affords people the opportunity to see how valuable this limited commodity really is.
Photo Caption: The global oil industry was the pandemic’s first victim.
Photo Credit: Pixabay