More oil price hikes, a recession and a brewing oil war

Last Oct. 5, OPEC-Plus agreed to cut oil production by two million barrels per day or two percent of global supply. Not only will this aggravate inflation all over the world, it will also accelerate, prolong and deepen the global recession that is certain to occur next year.

For those unaware, the Organization of Oil Exporting Countries (OPEC) is a group of 13 nations, mostly from the Middle East. The “Plus” represents 10 non-OPEC members that also export oil. This includes Russia. Russia is the 3rd largest oil and gas producer, accounting for 11 percent of global supply. Europe is its biggest customer.

Some context on oil prices… Before the pandemic, oil prices were at $62 a barrel. As of January 2022, prices increased to $79/barrel due to the logistics interruptions resulting from the contagion. It spiked to $110/barrel when Russia invaded Ukraine and settled at $85/barrel as of last September.

With oil prices increasing over three years, OPEC-Plus countries enjoyed scandalous profits. So why are they inducing another round of price hikes?

The quick answer is they are hedging the effects of next year’s recession. See, demand for oil is seen to drop drastically as the US and Europe undergo economic contraction. Naturally, this will result to a proportional decrease in oil prices. In fact, some analysts predict that prices can bottom at $50/barrel. So to cushion the anticipated price drop, OPEC-Plus is pushing  up prices today.

But here’s the problem – by instigating another oil price hike, OPEC-Plus is effectively pushing global economies even faster into a long protracted recession.

As it stands, the economic situation in the US and Europe is already worsening by the day. If their energy bills increase further, their governments will have no choice but to borrow more. More sovereign bonds will flood the market, which will push interest rates up. Higher interest rates mops up liquidity and curtails consumer demand. It discourages investments in new business ventures too. As economies get weaker, their currencies depreciate. This, in turn, will make importing oil even more expensive. It is a vicious downward cycle.

Note, there is already a cost of living crisis in Europe and the US, what with inflation hovering between 8 percent to 11 percent, the highest in 40 years. So another price hike will push many households to breaking point.

But there is another side to the story. As oil prices increase, OPEC-Plus countries, including Russia, stand to enjoy windfall profits. To appreciate the extent, Russia’s oil exports from March to July in normal years amounts to some $50 billion. This year, it was $90 billion on the back of the price hikes. This amount will increase even more when production is cut. Russia uses her windfall profits to finance her Ukraine invasion.

The US and UK are not taking the situation sitting down. The US is working to pass the NOPEC Bill while the UK is looking to impose price caps and insurance sanctions.

The NOPEC Bill is meant to punish oil-producing countries for weaponizing energy. It will revoke the sovereign immunity that has long protected OPEC countries and open them up to Anti-Trust lawsuits.

The NOPEC Bill has been on the American legislative agenda for two decades – but it never passed. Why? Because politics got in the way. This is because Saudi Arabia is the biggest importer of US weapons, having purchased $13 billion worth of arms between 2015 to 2019. If NOPEC is passed, Saudi Arabia threatens to buy arms from Russia instead, a move that will deprive American arms manufacturers of revenues. Less revenues for American arms makers means less campaign contributions and less lobby money for American politicians.

Another reason is one that relates to currency. If the NOPEC Bill is passed, OPEC countries can retaliate by mandating the use of the Russian ruble, instead of the US dollar, to purchase oil. This will remove the US dollar’s status as the supreme currency of the world.

American legislators say that the situation today is different since it is existential. US President Joe Biden is pushing hard for NOPEC’s passage.

For its part, the UK is proposing a “price cap strategy” to be applied to the importation of Russian oil and possibly those from the Middle East.

The “price cap strategy” calls for European countries to buy oil from Russia at a pre-determined price. If not, they will not buy from it at all. The UK’s leverage is that 95 percent of all marine insurance companies are based in London. If Russia (and OPEC-Plus countries) does not accede to the pre-determined price, British insurers can elect not to insure their oil shipments anywhere in the world. This will paralyze their economies.

The Philippines is not insulated from this raging oil war. When the US and western economies fall to recession, the impact on Philippine exports will be palpable. When oil production is cut and energy prices increase, our inflation will spike and our import bills will increase too, thereby worsening our already alarming trade and budget deficits.

If, however, the US and the UK’s plan succeed and OPEC-Plus decided to reverse their intended production cut, the Philippines will benefit from stable and cheaper oil prices.

As a bystander in this oil war, the best thing the Philippines can do is insulate itself from the shocks. There is no getting away from it – we need to become economically stronger by being less dependent on imports. We need a strong manufacturing and agricultural resurgence. How to pull it off is a topic for another piece.

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Email: [email protected]. Follow him on Twitter @aj_masigan