I suspect that view would be a mistake this time around. The world is experiencing much more than a temporary dip in oil prices. A change in the supply model marks a fundamental shift that will likely have long-lasting effects.
Through the years, markets have been conditioned to expect OPEC members to cut their production in response to a sharp drop in prices. As the biggest producer, Saudi Arabiawas willing and able to absorb a disproportionately large part of the output cut in order to stabilize prices and provide the basis for a rebound.
It did so directly by adhering to its lowered individual output ceiling, and indirectly by turning a blind eye when other OPEC members cheated by exceeding their ceilings to generate higher earnings. In the few periods when Saudi Arabia didn’t initially play this role, such as in the late 1990s, oil prices collapsed to levels that threatened the commercial viability of even the lower-cost OPEC producers.
Yet in serving as the swing producer through the years, Saudi Arabia learned an important lesson: It isn’t easy to regain market share. OPEC is no longer in a position to lower its production even though oil prices have collapsed by about 50 percent since June.
This change in the production model means it is up to natural market forces to restore pricing power to the oil markets. Low prices will lead to the gradual shutdown of what are now unprofitable oil fields and alternative energy supplies, and they will discourage investment in new capacity.
As costs fall for manufacturing and a wide range of other activities affected by energy costs, and as consumers spend less on gas and more on other things, many oil-importing nations will see a rise in gross domestic product. And this higher economic activity is likely to boost investment in new plants, equipment and labor, financed by corporate cash sitting on the sidelines.
The likelihood of longer-lasting changes is intensified when we include the geopolitical ripple effects. In addition to creating huge domestic problems for some producers such as Russia and Venezuela, the lower prices reduce these nations’ real and perceived influence on other countries. Some believe Cuba, for example, agreed to the recent deal with the U.S. because its leaders worried they would be getting less support from Russia and Venezuela. In countries such as Iraq and Nigeria, low oil prices can fuel more unrest and fragmentation, and increase the domestic and regional disruptive impact of extremist groups.
A prolonged period of low oil prices is likely to result in durable economic, political and geopolitical changes that, not so long ago, would have been considered remote, if not unthinkable.
