Though easily mistaken for an established law of physics, the term “Murphy’s law” is actually an adage with an easy-to-grasp meaning: ‘anything that can go wrong, will go wrong’. Whilst almost everyone could easily relate to this generic epigram, influential members of the Organisation of Petroleum Exporting Countries (OPEC) – especially decision-makers in Saudi Arabia – would probably acquiesce with that statement. An examination of the fundamentals behind the recent tumbling in oil prices and its geopolitical impact may shed some light on the reasoning for associating Murphy’s law with the erstwhile ‘sultans of swing’ in the oil industry.
The prime cause for the oil price collapse is unquestionably attributable to market forces – that is forces of demand and supply. Thanks to new innovative ways of drilling such as hydraulic fracturing, the United States of America (USA) has emerged as the world’s swing producer. Hydraulic fracturing, or “fracking”, is the process of drilling and injecting fluid into the ground at high pressure to fracture shale rocks to release oil and natural gas inside. Fracking has enabled the USA to increase oil supply by 4 million barrels a day since 2009. Coupled with that is the slowing growth rate of Chinese oil consumption over the previous years, all leading to a glut in the world market.
Though a common behavioral bias is to find monocausal explanations to complicated phenomena, we must wake up to the notion that the gyrations of oil price are not solely explained by economics. Geopolitics also has its say and the sustained low prices of oil also finds its roots in the decision taken by Saudis and other Gulf producers not to curb their productions. But why would substantial producers wish to maintain high supply and low prices, causing a drop in their own revenues?
The first reason is a tactical commercial move to oust the new American players who were a competitive threat. Fracking is a high-cost way of producing oil and below a certain price it would be uneconomical for the American producers to continue drilling. Though initially the Saudis’ move seemed to have this desired effect, Murphy’s law started to kick in. Some American producers did have to move out of the market, but the majority sticked around and responded by squeezing costs and making efficiency gains. Being flexible, those that moved out would be ready to move back in the market once the oil price started to pick up. An innovative mindset also helped them make huge productivity gains – within a decade or so the USA is expected to produce as much energy as it consumes.
In addition, Saudi Arabia’s will to maintain low prices by keeping supply up was reinforced by the belief that Iran would be more hurt by the low price. Saudi Arabia (as leader of the Sunni Muslim world) and Iran (as leader of the Shia Muslim world) are involved in a decades-long strategic rivalry for power and influence in the Middle East. The two countries are currently fighting a proxy war in Yemen, with Iran backing Houthi rebels (Shia minority) and Saudi Arabia supporting (military-wise) the Sunni-led central government. Saudi Arabia, with reserves of over $700 billion would be better able to ride a period of low oil prices than Iran which is afflicted by sanctions imposed by USA and other countries. However another instance of Murphy’s law seems manifest. The USA has recently engaged talks with Iran and is paving the way for reducing sanctions in return for curtailing its nuclear proliferation. America’s dependence on oil having diminished and assuming a deal reached with Iran nuclear non-proliferation, it is likely to disengage from the region and instead focus on the South East Asian region with China throwing its weight around. The spectre of an Iran free from sanctions and doubts about America’s readiness to defend them in case of conflict with Iran is raising concern for the Arab monarchies.
In light of the above, it may be inferred that what could have gone wrong, when taking the decision to maintain production in an era of declining oil prices, has gone wrong for the OPEC producers. However, a world with low oil prices has many winners. Consumers have more disposable income, industry benefits from lower energy costs, makes bigger profits and pays more taxes to governments.