The Economics and Politics of ‘black gold’

Oil – ‘Black gold’. Economies have been made and broken by it and wars fought over it.

It is essential in many products ranging from energy, transport, plastics to fertilisers.

This black gold is so fundamental to a modern economy that it can also play a crucial role in geopolitical rivalries.

Oil: The Commodity

Petrol, diesel and other fuels take up the bulk of the end product of oil but with better energy efficiency they are in relative decline.

Petrochemical products such as plastics account for a growing part of the end use for oil. The International Energy Agency (IEA) has reported:

“Petrochemicals are set to account for more than a third of the growth in world oil demand to 2030, and nearly half the growth to 2050, adding nearly 7 million barrels of oil a day by then. They are also poised to consume an additional 56 billion cubic metres (bcm) of natural gas by 2030, and 83 bcm by 2050.”

Oil: The Economics of ‘black gold’

Supply and demand, capital expenditure, labour costs, transportation and processing are the main factors behind oil pricing.

The Organization of the Petroleum Exporting Countries (OPEC), lead by Saudi Arabia, dominated oil pricing through the 1970s. It is still a major influence but is now under intense competition from the U.S. and Russia.

The U.S since its 2015 repeal of a 1975 ban on the export of crude oil has become a major exporter. Russia is once again a leading oil producer, recovering from the devastation caused by the Soviet Union’s collapse.

Upward pressures such as production outages and distribution bottle necks can impact prices. For example, this year Nigeria’s output was hit by pipeline shutdowns. A Canadian oil sands facility was shut down in June for nearly a month.

Pressures such as a strong dollar, economic weakness and trade wars can have a negative impact on price. Some of these I detailed in a previous article, ‘After trade oil is the next battleground’:

“On the announcement of tariffs on a further $200 billion of Chinese imports Brent dropped up to $1.

Interest rate rises and the dollar’s safe haven status have added further pressure on oil prices.

The IMF has warned that economic growth is under threat from trades wars. It follows that this would also have a negative impact on oil prices.”

Brent falls on tariffs announcement 11 July
Brent crude falls on tariffs announcement

Political tensions and geopolitical rivalries can add to price volatility. Iranian President Hassan Rouhani’s threat to stop oil shipping through Hormuz Straits  in response to U.S. sanctions was enough to cause market jitters and send prices up.

Oil: The Politics

All economies, in-spite of the growing renewables sector, are still heavily reliant on oil. Any denial of supply or export can have a serious impact and can have catastrophic consequences.

The U.S.’ sanctions shutting off the supply of its oil to Japan was one of the triggers for the Japanese attack on Pearl Harbour. That in turn brought the U.S. into the second world war.

Russian politicians in September reacted angrily to a speech by US Internal Secretary Ryan Zinke that the US navy could be used to blockade Russia’s energy exports warning that:

“A US blockade of Russia would be equal to a declaration of war under international law,”

Efforts by the U.S. to contain the rising power of China has led to military tension between the two in the South China Seas.

Malacca Strait oil chokepoint a danger for China

The supply of oil through a key chokepoint, the Strait of Malacca, is particularly sensitive to China. A 2015 U.S. Department of Defense report to Congress detailed that:

“In 2014, approximately 85 percent of China’s oil imports transited the South China Sea and Strait of Malacca.”

It’s not difficult to conclude that the South China Seas and oil transit are a potentially dangerous flashpoint between the two powers.

Oil: Price reflects instability

This is probably the most volatile period for oil since the 1970s oil crisis.

The sudden fluctuations in price and supply reflect the economic and political instability that has become the norm in the aftermath of the 2007/08 financial crash.

Oil pricing and supply has never been purely a case of simple economics. But now more than at any time in the recent past, oil is playing a key role on the geopolitical battleground between the established and rising powers.

Gary Hollands – November 28th 2018