The complexities of oil prices

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With holiday shopping right around the corner, U.S. consumers could have a little extra money in their pockets, thanks to lower gas prices. Saudi Arabia, the planet’s top producer and exporter of crude oil, lowered its prices for sales to the U.S., while raising prices in other markets.  

This is a first, according to Van Wood, Ph.D., marketing professor in the Virginia Commonwealth University School of Business. Wood has been the Philip Morris Chair in International Business at VCU for more than 20 years. Globalization particularly fascinates Wood, who has lived or worked in more than 90 countries.

“Saudi Arabia has never done this before,” he said. “They have always restricted output in the past when prices dropped in order to push prices back up.”

So what has changed? We asked Wood to look the proverbial gift horse in the mouth and explain this complex situation.

Why is Saudi Arabia cutting its oil prices for the United States?

It’s a human thing dating back to 1085 [when Islam split into Sunni and Shia factions]. Saudi Arabia, by keeping prices low, can put additional pressure on their Muslim rival Iran. While both Saudi Arabia and Iran are Muslim nations, Saudi is Sunni and Iran is Shia — these factions of Islam have been rivals for over 1,000 years.

From the political aspect, [Saudi Arabia] wants to hammer Iran. Iran is a backer of Hezbollah … and it’s a big deal and a part of the shifting sands in the region. As oil prices decrease, Iran is squeezed as it depends heavily on oil for economic and political viability. Saudi does also, but it has a trillion-dollar surplus and can wait it out much better. If they can lower oil prices, they can squeeze these guys out of backing Hezbollah. This rivalry has more detail, but that is the basics here. All of this involves the broader geopolitical issues of being an ally of the U.S., etc.

How will the United States react? Will we cease our own oil production?

By keeping prices low, Saudi Arabia can also deal with the U.S. and other new oil-producing competitors; as prices drop the viability of “fracking” decreases. Fracking, like all things, only works if it’s economically viable.  

What’s interesting is it’s always more complex than what people see. Once oil prices come down, business people think they have saved more money and can invest in other things. The economy starts picking up.

Once the economy takes off, people say there’s going to be more demand and prices go up.

How will this affect the U.S. economy in the long run? Is this good for us? Or does it cement our dependence on foreign oil?

I don’t think we’ll ever be as dependent on oil as we have in the past. China is embracing alternate energy sources, which is a good thing since China and the U.S. are the biggest polluters. What Germany has done with wind power, all nuclear power plants [will be] replaced with wind power. All the Germans said they don’t want nuclear power.

How will this affect our use and the development of alternative means of energy?

I think the really interesting story is what companies will be affected by the drop in oil prices. The oil price drop will affect different companies in different ways depending on if you are a seller or buyer. If you sell oil (or its derivatives - i.e., big oil companies) your revenue stream will drop. If you buy oil (airlines, buses, taxis), your cost will drop.

But also, with respect to oil and natural gas companies, those that have invested in new technologies in drilling, pumping, processing and transporting versus those that have not — this is a very interesting story.  Those that invested can keep their operating costs down and thus survive this price drop, those that did not will have more difficulty weathering this volatile time.  

Where do you see this leading? How long can these low prices last?

I don’t think it’s going to last at all. It’s a commodity. [However], if we become nondependent on oil, the long-term story of the world caring about the Middle East will be very interesting.

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