The other side of plummeting oil prices

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Ben D. Kritz

Ben D. Kritz

There appears to be no stopping the plunge in oil prices, at least for the time being, as the Oil Minister of the United Arab Emirates told a conference in Dubai over the weekend that OPEC would not even consider an emergency meeting to discuss moderating its output before March.

The minister explained frankly that OPEC is targeting market share rather than price in determining the 12-nation cartel’s collective output, and “We are not going to change our minds because the prices went to $60 or to $40 [per barrel].”

Benchmark oil prices reacted predictably. West Texas Intermediate, the US benchmark, fell to $55.59 a barrel on Monday in New York; Brent slipped closer to its $60 per barrel psychological barrier at $60.81; and Dubai Crude, the benchmark for most of the petroleum imported by the Philippines dropped even more, closing at $60.19 per barrel, with a settlement price at the Dubai Mercantile Exchange of $58.77.

On the face of things, there is no real downside for countries like the Philippines, which does not produce any amount of oil worth mentioning. Lower oil prices mean lower fuel prices, which in turn means lower prices on everything. Fuel prices are a significant contributor to the inflation rate and transportation costs, and any sustained price decline will eventually be reflected in lower prices of goods and increased consumption.


The process is happening. Most people here are disappointed the visible effects have not been more substantial—after all, the decline in oil prices actually started almost seven months ago—but the overall impact on the Philippine economy has been positive.

The positive effect on the local economy, however, distracts from some negative impacts the oil price collapse is having elsewhere, which may lead to some unexpected second-round effects here.

The biggest potential problem, one that already seems to be occurring in Russia, is that a few large national economies will suffer. Russia is a major petroleum producer but not a member of OPEC; already feeling the pinch by western sanctions imposed on it for its actions in Ukraine, Russia is seeing the oil revenue it needs to prop up its currency rapidly evaporating. An estimate by Bloomberg analysts last month suggested Russia has lost $2 billion in daily revenue for each $5 drop in the Brent crude oil price since its peak in June. OPEC members Venezuela and Nigeria are in similar straits, although not yet to the critical point Russia is; both countries need a price of about $100 per barrel in order to fund their governments, and are facing cutbacks in politically-important social programs if prices do not increase relatively quickly.

What effect a collapse of one or all of those economies would have on the rest of the world is a matter of speculation, but it would probably not cause much of a ripple in the Philippines. Some other effects of falling oil prices might. Airlines, who should benefit greatly from lower fuel prices, have been unexpected victims in some cases. Most airlines hedge at least part of their fuel requirements, and those who contracted future purchases at a range of $99 to $116 per barrel this year (the latest world average price according to the International Air Transportation Association was $85.80 per barrel) are incurring ironic losses. Cebu Pacific, for example, disclosed in its recent third-quarter report that it lost P149 million on fuel hedges through the first nine months of 2014. And because airlines purchase fuel contracts up to two years in advance, losses are likely to continue for some time.

Oil companies are likewise feeling the pinch; because the falling oil prices are fundamentally the result of a supply glut, oil producers and distributors have no opportunity to make up in volume what they are losing in margins. As one local gas station franchisee explained, “People don’t buy more when the price goes down. The customer who drives in and buys 200 pesos worth of fuel every time still does that, he just gets more fuel for the same price. And that means we make less profit.”

Major oil producers are also being hit from another direction as well. They typically rely heavily on debt to finance exploration and production, and as a consequence have racked up some $550 billion in bonds and loans since 2010. Revenues that are lower than the oil companies’ assumptions when taking on all that debt are putting some companies in jeopardy of defaulting on at least part of it; concerns about that have driven energy-related bond yields higher by nearly four percent since the end of June, further aggravating the problem by shutting even sound companies out of the debt market.

In OPEC’s view, the markets “will stabilize themselves,” but so far there is no sign consumption demand is picking up; if anything, it seems to be decreasing. In order for oil prices to start moving higher in a controlled way, it is estimated that world production needs to be cut by at least 3.5 to 5 million barrels per day (OPEC’s production ceiling, which it has exceeded for the past six months in a row, is 30 million barrels per day). That cannot be accomplished until OPEC acts, and since that won’t happen for at least three months, the concern now is that some of the serious side effects of falling oil prices will trigger a crisis that will cause prices to jump as dramatically as they have fallen.

Even if they don’t reverse themselves suddenly, oil prices will eventually increase; the only question is whether they will do so sooner or later. Since the possible ill effects of falling oil prices are far weaker than the positive effects as far as the Philippine economy is concerned, the country should be making a concerted effort to take full advantage of the short-term windfall; if it does not, it will be an opportunity we will all regret missing eventually.

ben.kritz@manilatimes.net.

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2 Comments

  1. mr kritz, since many of our ofws are in the middle east, their earnings/income would be affected by this fall of oil prices and some might lose their jobs. if this happens, and since our economy is being propelled by ofw remittances basically, then the effect on the overall economy is not good and would come earlier say a year’s time. pls enlighten us. thanks

  2. President Noynoy may be tempted to use half or practically all of the windfall from low-oil prices towards more Millenium Development Goals for Pilipinas poor. I hope he does this and ignore IBON and South Center wacko economics.