Post #8 – Did OPEC Just Chuck A BHP? Lenin Would Say ‘Yes’

Oil is our God. I don’t care if someone says they worship Jesus, Buddha, Allah, whoever – they actually worship petroleum

The good news is, ‘God’ just got a lot cheaper. No this isn’t another post having a dig at religion, but rather a discussion about oil. What better time to have this discussion then now, when the price of oil has practically crashed and it’s cheaper to fill up your car now than at any time in the last 5 years. But why is this the case, and why is it happening now? How does this relate to the world’s largest mining company? And what the hell does Vladimir Lenin have to do with any of this? I’m a nice guy, so I’m going to break it down into easily digestible points so that you know exactly what’s going on…

1. What is happening? – Simple economics is the reason behind the drop in the price of oil – but I must warn you that when it comes to economics nothing is really ever simple. The main culprit for the drop in oil is that supply is outstripping demand. That means, in layman’s terms, that more oil is being pulled out of the ground than is being used.

2. Why is it happening now? – A few different factors. First is the uptake of alternative forms of energy production – and when I say ‘alternative’, I don’t mean that hippy, green stuff like wind and solar, I’m referring to alternative means of extracting oil. America’s shale in the Midwest to the Canadian oil sands of Alberta are the main focus here. There has always been an abundance of oil in these two places, but it has usually been way too expensive to extract – until your barrel of oil hit $153 way back in 2008; then it became a lot more attractive. This period in time (however brief in time that was) made oil exploration and extraction companies all cocky and so they set off into the wilderness looking for the more expensive sticky ‘icky! As the analogy goes, all the low hanging fruit has been picked off the tree (i.e. the easy to extract oil is gone – it’s a finite resource after all) and the rest is harder and more expensive to get at. This means that when interest rates were at record lows and stimulus was being pumped through economies around the world, the time was ripe for large and small (and even start-up) companies alike to get in on a binge of cheap credit to expand and invest. The possible reward of cashing in when the price of oil shot back up again was too good to resist. With all of these companies attempting to flood the world with oil at roughly the same time the price has somewhat tumbled. Chuck in softening and stuttering economies all the way from China, to the U.S and Europe (mostly as a result of those stimulus packages ceasing) and efficiency targets taking effect (targets enforced after the 2008 spike in oil) and you’ve got a recipe for a pretty decent drop in the price of a barrel. Include countries like Iraq finally tapping into the global oil supply and you’ve nearly got the full picture. However, there is one more piece to this puzzle – and this is where BHP comes in.

3. What does BHP have to do with this? – Nothing really, but they could have very well inspired the situation we now find ourselves in. Colin Barnett, the current Premier of Western Australia, recently lost his shit quite publicly at BHP and Rio Tinto. Now, why would a conservative, pro-business, pro-mining leader of a mining state clash heads with the world’s two largest mining companies? Because, according to Barnett (and anybody with a brain) the two mining giants were colluding to drive down the price of iron-ore to flood the market and weaken the already soft prices for the commodity. Next rhetorical question: Why would these two companies continue to not just supply the same amount of iron-ore, but actually increase output if it means their operations are running at a loss? The benefit of them doing this is that they kill off the small to medium mining companies by making their operations unprofitable and sending their share price crashing – leading to insolvency. Then they swoop in as the saviour, bail them out, buy them up and share the spoils amongst themselves. To illustrate the strength of these two mining giants, they very nearly got the scalp of ‘Twiggy’ Forrest and Fortescue Metals out of all of this. The irony is that Barnett actually gave Rio Tinto permission to greatly expand their operations, thus essentially sowing the seeds for Rio to fuck him over. It fucks Barnett over in a couple of ways – 1. It makes him look like a dork for approving an expansion of mining operations on a resource with plummeting demand, and 2. It hits his state’s budget bottom line, as the royalties the state collects drops dramatically with the fall in commodity prices. Barnett has been swindled and he can’t do a darn thing about it. Where it draws analogies to what’s happening with the price of oil is that another massive market factor (OPEC this time) is supposedly colluding to keep the price of oil ridiculously low. I say ‘supposedly’ because these companies and/or states would never admit to colluding to alter the market in their favour – but that’s essentially what they’re doing. Instead of cutting output (which is what rationalist economic mantra would suggest they do) OPEC says something along the lines of ‘we really can’t be bothered to change the level of output’ – it’s a pretty illogical argument. The reason for this relates to our story about BHP and also relates to our story about the new players in the oil industry. As Tim Bowler reported for the BBC, “there could be two reasons [for driving down the price] – to try to instil some discipline among fellow OPEC oil producers, and perhaps to put the US’s burgeoning shale oil and gas industry under pressure.” At the time of writing this blog, NO oil producing country on the face of the earth is breaking even given the current price. At US$46.50 a barrel, the country closest to breaking even is Qatar with an asking price of $77 for a barrel of oil to cover costs. They’re also doing two massive oil-producing countries, Venezuela and Russia, no favours – and that’s just how they like it. Treat ’em mean, keep ’em keen!

4. What are the positive effects? – Well I just filled up my car for about $30 – that’s a positive. A cut in the price of oil usually has the effect of a tax cut too, so you should see a spike in economic activity, especially in countries dependent on oil imports, like Japan and NZ. Another winner are car companies, who are back in fashion with their gas guzzlers and SUV’s, much to the detriment to the environment and plain ol’ rationality. However, according to The Economist (17/1; p. 9) the most positive effect is that “the plunging price of oil, coupled with advances in clean energy and conservation, offers politicians around the world the chance to rationalise energy policy.” They recommend cutting subsidies in developing countries and scrapping tax-payer funded incentives in developed countries for oil exploration. Now is the time to incrementally wean us off the great, big teat of foreign oil and let the real price of this commodity be truly reflected. I remember travelling up to Suez from the Gulf of Aqaba in Egypt – we stopped at a petrol station to fill up a 12-seater Hiace and it cost us less than $10 – that was in 2011 at a time of high oil prices. In a cash-strapped country like Egypt, massive state-subsidies like this are ultimately unsustainable. Last year governments around the globe threw $550 billion towards subsidising either the production or consumption of fossil fuels (The Economist – 17/1; p. 9). The positive out of this oil crash is that we can stop this madness today and get out relatively unscathed. If implemented correctly, there could be a real revolution in how we structure our energy policies.

5. What are the negative effects? – Real revolution, again, but of a different and more violent flavour. Expect to see Libya, Venezuela and Russia partially or even completely fall apart if the oil price does not bounce back sometime soon. All three countries are heavily dependent on oil and don’t really have very diversified economies. Despite most of the OPEC nations having a surplus from the previous years of high oil prices, expect to see a winding back of welfare, hand-outs and expenditure in most of the Arab states. Considering the precarious situation most of these countries are still in after the Arab Spring, many of these countries could be seen as a tinderbox just waiting for a jolt – such as a sustained drop in oil prices – to explode again. If the Arab Spring: Round II does eventuate, expect to see oil prices rise quickly back to what they were. Markets like stability; a revolution or a civil war don’t really provide that. Deflation is another real concern, but the biggest concern may be complacency. A real negative is that we forget the lessons we learned after the oil shocks of the 1970’s and 2008 – that we can’t be so dependent on all this oily stuff! OPEC wants to lull us into a false sense of security – first by undermining our local producers of gas and oil with cheap prices, and secondly by glossing over our addiction to oil with further discounted prices. We mustn’t fall for the same trap again.

6. What does Vladimir Lenin have to do with this? – This peculiar situation we find ourselves in, where giant corporations (and state-sanctioned corporations) happily run at a loss for long periods of time to weaken or destroy their competitors, was actually predicted by Lenin (the revolutionary Marxist, not the bi-spectacled dude from the Beatles) in 1916. He referred to it as an evolutionary process (he formulated this idea in the midst of WWI) – from a laissez-faire style of capitalism into what he referred to as ‘monopoly capitalism’. The term refers to an environment where the state intervenes in the economy to protect large monopolistic (or at best, duopolistic) businesses from competition by smaller firms. What he may not have predicted is it happening on a global scale now – a perfect example being Saudi Arabia’s oil company Saudi Armaco which is currently squeezing U.S and Australian corporations and start-ups with a helping hand from its overlord, the Saudi Royal Family. According to Lenin, once these corporations have achieved a monopoly or cartel position in most markets of importance (i.e. minerals or oil), they essentially fuse with the government apparatus. In the case of OPEC, an example would be the Abu Dhabi National Oil Company (no prizes for guessing where they’re based, or which Royal Family they’re cozy with), and in the case of Western Australia (whether Colin Barnett likes it or not), it would be BHP and Rio Tinto. Because of this collusion (on a massive scale) a kind of financial conglomerate is therefore created, whereby government officials aim to provide the social and legal framework within which these giant corporations can operate most effectively. They can then sow the seeds of their own destiny, the ‘forces of the market’ become an irrelevant afterthought, consigned to the pages of Economic textbooks in theory only.

So there you have it ladies and gentlemen: oil is your God, and most likely will be the one you revere for the foreseeable future. But times, they are ‘a changin’, and I feel we may be on the cusp of a pivotal upheaval in regards to our energy usage; ironically, it’s at a time when it is the cheapest and most abundant it has been in years. Hopefully armed with the information I’ve provided, you can make sense of it all and start limiting your worship of oil – or at the very least start thinking of a future without it dominating your life so much.

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