My mom in California is elated — gasoline prices are below $4 a gallon for the first time in months. Less so are the world's petro-rulers, who are watching the price of oil — their life blood — plunge at a rate they have not experienced since the dreaded year 2008. Industry analysts use phrases such as "devastation" and "severe strain" to describe what is next for the petro-states should prices plummet as low as some fear. No one is as yet forecasting a fresh round of Arab Spring-like regime implosions. But that's the nightmare scenario if you happen to run a petrocracy.
To understand why your average oil king is right to be worried, grab your calculator. The price of U.S.-traded oil fell to $83.27 a barrel on Monday, and global benchmark Brent crude to $96.05 a barrel; but the budgets of Iran, Russia and Venezuela, which require more than $110-a-barrel to break even, according to generally accepted estimates.
One might fairly wonder what would happen if, as Citigroup's Edward Morse says is possible, prices drop another $20 a barrel for an extended time. Oil economist Philip Verleger's forecast is even gloomier — a plunge to $40 a barrel by November. In Russia, for instance, "$35 or $40, or even $60 a barrel, would be devastating fiscally," says Andrew Kuchins, of the Center for Strategic and International Studies. That could damage the standing of President Vladimir Putin, since his "popularity and authority are closely correlated with economic growth," Kuchins said in an email.
With few exceptions, the same goes for the rest of the world's petro-rulers, whose oil revenue supports vast social spending aimed at least in part at subduing possible dissatisfaction by their populaces. Saudi Arabia can balance its budget as long as prices stay above $80 a barrel, according to the International Monetary Fund, although projected future social spending obligations will drive its break-even price to $98 a barrel in 2016.
The biggest uncertainty in the global oil market isn't whether oil prices will drop further, but how long they will stay down. This state of affairs is a woeful blow to petro-rulers after nine years of mostly nirvana. The year 2003 started with oil at about $33 a barrel, after which prices went mainly up, peaking in July 2008 at $147 a barrel. When the Arab Spring unfolded, first Libya and then Iran triggered worries on trading desks in London and New York, and the price spiked to about $128 a barrel. But then the concern of war between Iran and Israel all but vanished, and prices since have been on a seemingly relentless decline.
Now, a convergence of forces is weighing on petro-rulers' nerves: Europe's economic crisis; a slowdown in Chinese growth including the demand for oil; a steep decline in U.S. oil consumption with a simultaneous rise in domestic oil production; and a determined effort by petroleum colossus Saudi Arabia to build up global inventories.
Saudi Arabia's aggressive actions to lower prices might seem baffling given Riyadh's economic stake in the oil game. But Verleger says the Saudi rationale is clear, and linked to the kingdom's traditional long game.
In an email exchange, Verleger says the Saudis are out for blood when it comes to fellow petro-states Russia and Iran, the former for failing to help calm the fury in Syria, and the latter for refusing to give up its nuclear ambitions; in both cases, the Saudis think lower prices will produce a more reasonable attitude. In addition, Saudi Arabia is terrified of a current U.S. boom in shale oil; it is hoping that lower prices will render much of the drilling uneconomical. Finally, the Saudis are well aware that low oil prices helped turn around the global economic downturn in 1998 and 1999, and they hope to help accomplish the same now, and perhaps win new affection from the world's leading economies.
Meanwhile, though, Verleger thinks oil prices will crash.
To the degree that such fire-sale prices are long-lived, they could cause mayhem among petro-rulers. Verleger thinks that the Saudis can maneuver prices back up when they want but the very nature of a crash demonstrates markets can be uncontrollable. The Saudis are willing to suffer the consequences, knowing their own financial reserves (some $700 billion) give them staying power.
Citigroup's Morse said he thinks prices can fall further but not as low as Verleger forecasts because today's market conditions are different from 2008 — the decline in demand is not as steep, and inventories are not as large. Morse calculates that Brent can fall into the $70s-per-barrel range. "There is a good chance Saudi Arabia continues to produce enough to force a rise in oil inventories. And there's a good chance, between Europe and China, that demand growth could come to a halt," Morse said. OPEC might respond by reducing production, but its actions would be late. "Add to the scenario no more supply disruptions (or only modest ones) and no military conflict involving Iran," Morse said, "and prices could fall another $20 a barrel fairly easily."
Low oil prices can have serious social impacts simply because, with less free cash, people tend to start more closely scrutinizing their surroundings — and when they become unhappy with what they see, they start looking for a scapegoat. The conditions that led to the string of Arab Spring ousters were not so much the lack of democracy as widespread public dissatisfaction with personal economic prospects. Analysts see similar vulnerabilities for the rulers of Iran, Russia and Venezuela.
Not everyone thinks the times will be so brutal for petro-rulers. Neil Beveridge of Bernstein Research said conditions may push prices as low as around $90 a barrel, but no more. The Energy Information Administration (EIA) on Monday estimated prices in 2012's second half at $95 a barrel.
The latter would be a heart-in-your throat, 10 percent plunge from the EIA's previous forecast. But it would be nowhere near the cliff that brings cold chills to the world's petro-rulers.