Author: Davit Shatakishvili, Contributing Analyst, American University, Washington
On September 5, Saudi Arabia, together with the Russian Federation, extended the decision made in June 2023 to reduce oil supply, prolonging it until the end of the year, which means a total reduction of daily oil supply by 1.3 million barrels, of which Saudi Arabia’s share is 1 million, and Russia’s 300,000 barrels. As a result, the price of a barrel of Brent oil on the trade exchange exceeded 95 US dollars, and the price of WTI oil reached 90 US dollars, which is the highest level since November last year. For comparison, in July, the average price of a barrel of Brent was 80 US dollars, and the price of WTI fluctuated around 75 US dollars. The price of Russian oil of the Ural type also increased, surpassing the upper limit of 60 US dollars set by the G7 countries and reaching 75 US dollars. According to Goldman Sachs’ forecast, by the end of the year, the price of oil may reach 110 US dollars per barrel. Despite requests from the United States of America and other Western allies to OPEC+ member countries to increase oil supply to maintain low energy prices and promote global economic growth, in response, OPEC+ says that they are trying to achieve “stability” in the energy market by reducing supply. Here, we will discuss what is behind the decision and, as winter approaches, how much it will affect energy-vulnerable countries and their economies.
Rising Energy Prices – the Interests of the Parties
Oil-producing countries benefit the most from increased prices for energy resources. For example, last year, Saudi Aramco, the state-owned energy company of the Kingdom of Saudi Arabia, earned 161 billion US dollars in net profit, which is a historic high for the country. The country is trying to mobilize financial resources to invest in ambitious infrastructure projects, including the construction of a futuristic desert city, called Neom, worth 500 billion US dollars. On the other hand, Saudi Arabia’s decision on the political level further complicates its relations with the United States. Last year, President Biden warned Saudi Arabia about “specific consequences” for its partnership with Russia, but it is still unclear what concrete steps the US will take in this regard. Moscow is also benefiting from increased prices for its energy resources. Under the eleven packages of sanctions imposed on Russia by the Western allies, skyrocketing energy prices allow the Kremlin to get more revenue to finance its aggressive war in Ukraine.
As much as triple-digit energy prices are beneficial for oil-producing countries, they may also have side effects. On the one hand, this process may contribute to an increase in the supply of shale natural gas from the US at a relatively low price, while, on the other, increased energy prices encourage countries to boost investments in renewable energies, which will greatly accelerate the green transformation process.
Rising energy prices have a direct impact on political processes throughout the world. For example, the United States is becoming ever more vulnerable to external shocks as the 2024 presidential elections approach. The American people are already criticizing the Biden administration for high inflation and other economic issues, and rising energy prices are further reducing the incumbent president’s approval ratings. In 2020, when Joe Biden took the presidential office, the price of 1 gallon of gasoline was about 2.4 dollars. Now, it is up to 4 dollars. That is why high energy prices will be among the important pre-election issues. According to some experts, by trying to artificially increase oil prices, Saudi Arabia seeks to influence the presidential elections scheduled for 2024 in the United States, and thereby show support for Donald Trump. Thus, OPEC+ member states, which produce approximately 40% of the globe’s crude oil, obviously play a key role in shaping energy market prices, which also allows for their own political and economic dividends.
The Global Effect of Energy Prices
In June, when Saudi Arabia decided to reduce its oil supply to the market, global leaders began actively discussing who might fill the market deficit. According to Bloomberg, negotiations between the United States and Iran regarding oil supply have been renewed behind the scenes. Meanwhile, sanctioned Venezuela, which has the world’s largest crude oil reserves, has started talks with China to restore supplies. The experts consider Iran and Venezuela the main alternative sources for bridging the oil market gap, even though this process is likely to be politically unpleasant. Considering the current situation, this step is seen as one of the few real solutions that can contribute to the stability of consumer prices and the protection of the world’s economy from external shocks.
As winter approaches, the European Union is also actively preparing to protect itself from potential energy difficulties. According to the European Commission, 90% of the EU’s energy reserves have already been filled, and it is estimated that the strategic reserves will be fully filled by November. At the same time, the European Union actively continues to arrange the necessary infrastructure for liquefied natural gas (LNG). Compared to 2021, the consumption of liquefied gas in Europe has doubled, with the main supplying countries being the USA and Qatar. This allows Europe, together with stable partners, to be less vulnerable to energy prices.
Skyrocketing prices for energy resources lead to increased transportation costs and are the main source of inflation. To deal with high consumer prices, central banks raise the monetary policy rate, which in turn reduces the efficiency of the economy. It is likely that this trend will continue until the end of this year, considering inflationary expectations.
The European Commission reduced the forecast growth rate for the EU economy in 2023 from 1% to 0.8%, and in 2024 from 1.7% to 1.4%. According to them, the weakness of domestic demand, especially on the consumption side, shows that high and still rising consumer prices for most goods and services have a greater negative impact than previously expected. At the same time, it is currently unknown what decision the European Central Bank will make regarding the monetary policy rate.
OPEC+ member countries’ decision to cut oil supply until the end of this year creates both economic and political risks, and increases global uncertainty. First of all, it will have a macroeconomic effect, which will be reflected in increased consumer prices and a tightening of the monetary policy by the central banks. This, in turn, hinders the normal functioning of the economy, although it also helps to restrain the rising inflation. In the coming days, the meetings of the monetary committees of the European Central Bank and the American Federal Reserve will be held, where a decision about the refinancing rate will be made.
It is not yet clear which way the leading countries will choose to fill the market energy deficit. In this regard, both Iran and Venezuela are considered real alternative sources. The approach of winter and the increased energy consumption in the world are prompting the states to make more radical decisions than were needed during the summer. In addition, leading investment banking organizations are predicting a further increase in oil prices by the end of the year, which may even exceed triple digits.
Thus, countries have to make efforts in several main directions. On the one hand, they have to provide their population with the necessary energy resources without any interruptions during the winter period, and on the other, to make fiscal and monetary decisions that will bring inflation under control and not endanger people’s purchasing power. The situation is further complicated by the uncertain course of Russian aggression in Ukraine, as there is a need for huge financial and military resources in this direction, from both Europe and the United States. We are expecting, in the near future, Washington’s specific reaction to the actions of Saudi Arabia, the de facto leader of OPEC+. However, all we know today is the clear fact that Riyadh is pursuing its own interests without any obstacles and is achieving political and economic dividends.