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Crude Oil, the Sword and the Power of Economics

By John Karoly
Chicago, IL, USA

John Karoly
John Karoly

In March 2001, on the occasion of the turn of the century and the millennium, the Department of Energy made a study with the title of "International Energy Outlook," giving a 20-year projection of the world energy requirements and supply. The primary purpose of the study was to project the price and supply sources of crude oil 20 years into the future.

The report was authored at a time when crude was trading, after a 13-year turmoil in the market, at the price it traded at prior to the turmoil. The turmoil and the rise of crude prices were caused by the Arab oil embargo, Iran/Iraq War and the Iranian Revolution. Following these events, in 1986, the crude price returned to the level it had traded in the prior 30 years. This was the same price that crude traded at the time the report was written when crude was trading at the $20 range. Thus the authors of the report were, seemingly, perfectly justified by the data to peg crude oil prices in the year 2000 at $20/barrel and start the analyses from this price. As soon as the report was published, however, crude prices started a steep climb, thus the price projection of the report became erroneous almost immediately as the DOE made a linear extrapolation for the next 20 years starting with this low crude price. After the publication came 9/11, Afghanistan, Iraq war, supply shortages, all of which drove the price of crude way up. Once this period ended with the burst of the housing bubble, we and the world experienced a severe recession which brought the price of crude down. Then the disturbance in the Middle East caused by the Arab Spring made the price of crude move to an all-time high. All this happened in the 21st century. And finally the US shale oil production coupled with worldwide excess crude and the start of a recession drove the price of crude down. Almost 15 years after the publication of the DOE report and after this roller-coaster ride, the price predicted by the report for our times of about $36/barrel turned out to be correct. One may consider this a coincidence but what is significant in all this price fluctuation is that crude prices climb with political and geopolitical events, but they consistently return to the prior steady price of $20/ barrel, or, adjusted to inflation, to about $36-$40.

During the past 70+ years the price of crude was around $20/barrel the majority of the time (65%). The recent downturn back to this equilibrium price points to the direction of crude oil trading around current prices, around $40, for the next decade, or longer, based on historical precedents. Naturally, we always have to allow, as in the past, for unforeseen events, and we might quickly add that most events are unforeseen, which could cause spikes in crude prices as they have in the past. The conclusion we have to draw, however, from the past many years, is that price spikes are the unusual events and the equilibrium normal price around $40/barrel is the norm, rather than the other way around, as we assumed during the first 10+ years of this century. The lack of realization of this, myself included, caused and is causing huge dislocation both in the market and in the industry and, in fact, in our daily lives. And it seems that this has not yet sunk in with most: the prevailing view is that oil prices will "return" to the levels we saw in the early part of this century to the $80-$100 level, and the low price is the aberration. However, if this analysis is correct, environmentalists don't need to picket fracking operations or Canadian tar sands or pipelines coming from Canada's tar sands for some time to come – for well in excess of a decade. Cheap crude oil price is here to stay until the world decides to drive SUVs. In a way it is a pity. Cheap oil is environmentally unfriendly as it increases consumption and thus pollution.

The low crude oil prices are wrecking the economies of all the countries which primarily live off the revenues derived from crude oil. Furthermore, since their budgets expanded with the elevated crude prices that prevailed throughout most of this century, now they are in trouble. Saudi Arabia, the wealthiest oil exporter, is in deficit spending and it is liquidating assets and issuing bonds to cover expenses. Russia is virtually bankrupt. Other Middle East states are hurting much like Saudi Arabia.

And now, furthering the problems of crude, comes the VW fiasco. This is a major event as it affects the many millions of diesel cars sold throughout the world whose owners would likely wish to rid themselves of these vehicles, while others are not likely to buy diesel automobiles, thus further cutting into the crude oil demand. Over time the diesel automobiles are likely be replaced by some version of electrical and gasoline hybrid vehicles in addition to plain conventional automobiles, hopefully not SUVs.

Wars also cost money, lots of it. There is not any other undertaking by man which is as expensive as a war. They last a long time and put the perpetrators in a severe deficit or bankruptcy. It has bankrupted many countries and more often than not, it was the cause for the loss of the war. Germany and its allies were bankrupt after the First World War and again after the Second World War. Reagan was instrumental in bankrupting the old Soviet Union by causing an arms race which the US could withstand and which USSR could not afford. This was a clever way to defeat an enemy without loss of life. No Russian or American died in a "conflict" which could have had a disastrous outcome as both were and still are major nuclear powers.

The examples of the extreme costs of wars go back to the Roman Empire and well before, to the Persians, and even before. But in addition to the cost of wars, wars were "won" or lost due to natural causes, like Napoleon's Grand Army which was defeated by the Russian army but only after the Russian winter of 1813 devastated the Grand Army; it reduced it to almost 1/5th of its size by the time it reached Moscow. Hitler must not have ever read the history books and attacked the USSR and lost to the Russian winter and the army at St. Petersburg. Wars were also lost to famine, etc. Bush "won" the war against Iraq until he lost it against the American people who desired to end the war. Invading armies were able to keep occupied territories until they had to withdraw due to cost, attrition, etc. The USSR invaded Afghanistan and was beaten after four years and had to withdraw. Bush ignored this and shipped a great deal of armament over to Afghanistan for a war which is still going on, but we are, certainly not winning. One wonders if an honest evaluation were to be made, discounting all political motivations, how foreign military ventures in history were truly won by military means. One may assume rather few and even fewer with lasting effects which would allow the claim that it was worth the price paid.

Today, there are wars and terrorism ranging all over the Middle East. Who pays for all this and what is the source of the funds? Could it be outside of oil revenues? Very unlikely, in fact, virtually impossible. Kidnappings, looting and similar terrorist behavior could not bring in anywhere near the funds required to wage a long duration war and short and inexpensive wars do not really exist.   

While oil revenues were high, there was money available from terrorist sympathizers who wanted to create trouble or wanted to support the troublemakers. But today this is, or it must be, a different story. One would assume that with oil exporting nations having a fraction of their past incomes, with extended budgets which were supportable with the high oil prices but no longer are, these terrorist sympathizers are bound to be hurting badly and should not be willing to finance tribal/religious/ideological wars. They have problems maintaining their living standards, protecting against internal problems, and could not very well be thinking about supporting expensive and rather pointless wars and terrorism of larger scales.

It would appear that the diminishing news of new major attacks by ISIS points this direction. Attacking unarmed civilians does not take a lot of ammunition or cost a lot of money. The material looted from the various entities is bound to run out unless we ship them new supplies. The belligerents are also suffering from the low crude oil prices as they have access to wells within their jurisdiction.

Even if the historical data is just that and oil prices were to rise above the $40-50 range, the rise should be seriously tempered by the US domestic shale oil which can be switched back on line at a rather short notice. Furthermore, all kinds of hydrocarbon discoveries from various sources at various parts of the world are announced almost monthly, plus all the natural gas and crude oil which was discovered during the last years, will keep crude prices in the low range, supporting the data discussed above. It is safe to say that crude oil prices could not appreciably increase above the current prices and will stay well below the prices oil exporters need to run their own budget. This is a changed world from that we have known in the early part of this century (or millennium), but it seems to be well supported by historical data.

It is surprising to hear some of our supposedly seasoned politicians talk about requiring "boots on the ground" to defeat ISIS and whomever. This is especially amazing as our military –consisting of well-educated and knowledgeable members – advised that there is no military solution to the ISIS problem. Why? One would assume that one of the reasons is that the enemy is a totally undefined, fluid and daily changing mess. Probably no one can make any sense out of who is fighting whom and for what reason, if there is a reason. The pilots sent out on missions from aircraft carriers often return with full ammunition. They could not find any verifiable enemy and are loath to bomb potentially innocent civilians. And there is no inclination on the part of the military or the American people to get involved in another losing military campaign.

As we are writing these lines, our situation became more complex. Mr. Putin got involved in the Syrian theatre. He too is shipping in war material at no doubt a large cost. If he gets bogged down, and we should make sure that he either gets bogged down or gets out, his costs are going to mount. He will have to pay for the "boots on the ground" dearly and he can't afford it. If he runs into us, he might risk a catastrophic war with us. He does not want that. He is bombing the civilians and hoping to create an even larger refugee problem for Europe. Putin understands the economics of oil; he knows he can't go on at the historical price. By joining the bombing and shooting in the Middle East, he can hope to eliminate some competitors while contributing to the war which could give a rise to crude prices as it did in the past. That could save him from the inevitable bankruptcy even if only temporarily.

Crude prices can spike based on fear in the markets. When disturbance is high, prices go up, temporarily. However, it cannot stay up on a prolonged basis unless there is a shortage or an all-out major conflict. Barring a major conflict, our oil fields combined with reduced demand, as discussed, will ensure that there is no shortage and crude prices are bound to return to their historical value around $40-50/barrel. No one is saved by temporarily higher crude prices, not Putin, not the terrorist, not the Middle East oil producers. When crude returns to the "normal" price, Russia will bleed faster after all it has "boots on the ground," body bags full of dead soldiers and disabled war veterans on their way home.

With patience, without stupid macho actions and with the help of our oil supply, we can defeat the terrorist and now Mr. Putin without our "boots on the ground" and without providing weapons to our enemy. Our oil companies are the weapons we need. Fracking is a lot better alternative to anything else. Frackers don't behead people. We should remember that wars take a very long time and this war should be fought with the weapon of economics. It could take longer or shorter to win this type of war, but we have nothing to lose if we act with patience.


All opinions expressed in this article are solely those of its author and do not reflect the opinions of Stay Thirsty Media, Inc.

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