Falling oil prices: Happy days at the pumps, Hummerized Priuses surely on the way, and what on earth happened anyway?

If you follow the news much, and if you don’t I don’t blame you, you may have noticed apocalyptic noises about how oil prices are, in ascending order of doom, in free fall, crashing, being obliterated, annihilated, etc., grand overstatements each trying to outdo the previous (in actuality, oil prices fell from around $100/barrel to ~$65 as of this writing, a large drop for sure but oil prices are usually volatile, maybe the media should reserve the bombast for when it’s really needed?). Assuming you aren’t a motionless recluse, you most likely move around a bit and therefore have good reason to celebrate any fall in oil prices. The people that pull up to the pumps and put in 10 bucks worth are no doubt on top of the world, because they can now put in 14 bucks worth (that’s how economists think anyway).

Who doesn’t get happy to see lower prices at the pump? It’s like finding money on the street. On the other hand, some of us (the word “killjoys” springs to mind) sit around and ponder what events like this mean for other sectors of the world.

First off, what exactly happened to drive oil prices down so much? The answer is…pretty much nothing. Here’s the history of oil prices in a nutshell. Since the beginning of time oil prices were fairly steady, until the early 1970s when OPEC (Organization of Petroleum Exporting Countries) decided they wanted a raise. They stopped oil exports, the world ran short of gasoline, prices exploded, and the modern era of volatile oil prices began. Ever since then, OPEC has fretted and chewed its well manicured nails (billions of dollars in revenue every day pay for some serious grooming) over how to manage oil prices. OPEC wants them as high as remotely possible, because high oil prices drain money straigth from your pocket to theirs. On the other hand, if oil prices are too high, everyone starts looking for the stuff everywhere, and if they find enough that drives the price back down. If they find sufficient quantities of new oil, these petroleum badgers could put OPEC right out of business.

So that’s the balancing act OPEC tries to maintain, and this time it looked like things were getting out of hand. US oil producers have found ways to extract oil from geological formations that previously had been too difficult or expensive to get out. With oil at $100/barrel, they suddenly found a way and OPEC shrieked like a little girl. OPEC’s normal tactic in this scenario is to reduce their output enough to cause shortages and drive prices back up. This time however, OPEC was scared that this oil extraction technology boom would spread to other parts of the world, greatly increasing production all over the place and causing a serious glut.

So, OPEC decided to put a dagger in the heart of this new shale oil business by driving down global oil prices. They did this by doing… nothing. All they did was refuse to cut production, meaning a glut of oil may be allowed to build up, and the traders/speculators took over. Traders love shit like this: crazy end-of-the-world headlines, scared producers, rumors flying around…it’s a traders dream. They happily fuel the fire, making bets in the markets then even chirping to the news about how the world is ending, or whatever, creating volatility and instant, huge profits (all totally unproveable, of course, you can fine these guys a trillion dollars and they’ll settle for a few measly hundred million without ever admitting to wrongdoing).

Anyway, as of now the world produces slightly more oil than is consumed (by a little bit, not a huge amount), and the commodities markets have had a field day slicing 30 percent off the value of all oil on the planet. But fundamentally, nothing changed in the past weeks that hasn’t been around for the past few years; the pot just finally boiled over.

Will oil prices stay low? I wouldn’t bet on it, though they might go a lot lower over the next few weeks as the speculators squeeze out every nickel they can. Most OPEC nations can’t afford prolonged low oil prices, because they have accumulated too many expensive habits and habitually pay off citizens with various baubles to keep the peace. Keeping the peace is no small feat in the Middle East. If oil prices stay this low by next summer’s next OPEC meeting, the band of filthy-rich-but-paycheck-to-paycheck countries will demand some sort of action to bring prices back up. For now, get out there and drive, and order the V8!

Obviously, consumers are happy with the fall in oil prices because a fall in oil prices is a direct transfer of wealth from oil producers to the pockets of oil users. Who wouldn’t like that. The numbers are staggering too – the world consumes 90 million barrels per day, so with a price drop of $30 per barrel, that is about $2.7 billion per day handed back to consumers, more or less, with maybe 10 percent of that destined for US consumers who tend to put extra cash to work at the mall quite promptly. A large price drop in a basic staple like gasoline can do wonders  for citizens and economies if you weren’t expecting it, and can cause right proper hell if you were banking on prices not falling  – a lot of oil producers and miscellaneous countries that export oil are realizing the Christmas stocking is not only going to be skinny this year, it’s going to be devoured by hyenas (though in reality most of these oil exporting countries don’t celebrate Christmas, nor are their citizens hyenas. They might turn out to be once their governments’ cash flow dries up though.)

On the other hand, governments of countries that import oil are pretty pleased with this market mayhem. Falling oil prices are very good news for politicians and governments trying to balance stretched budgets and get the economy going. Falling oil prices are like reducing taxes, leaving more money in the pockets of oil consumers every day. This helps the government because extra cash in the hands of consumers means they spend more, boosting the economy, creating jobs, and making politicians look capable at their job without even doing anything (one could argue that the second they do anything things get worse, so getting credit for any business climate improvements while just sitting there is a best case scenario for the average bureaucrat).

Once beyond those two happy groups of consumers and oil-importers, things get murkier, because a large swing in oil prices, if it remains for a long time, will be destabilizing and possibly quite negative on a number of fronts. For example one effect will be more instability in various oil producing countries that rely on oil sales for a large part of their revenue. If you’ve ever had a raise at work, you know how easy that newfound money is taken for granted, and how the feeling of being much richer doesn’t last long. Well, when reversed, that is when your pay gets cut, the effect is multiplied and excruciating. That’s the circumstances oil producing countries find themselves in. When citizens are used to various handouts, subsidies, new roads wherever they go, etc., they get really pissed off when told that all that stuff isn’t affordable anymore. (Except Russia, they seem very stoic and accepting of periodic ups and downs, and have full faith in their bonkers leader to manage the Soviet machine…) And if a wounded Russia doesn’t concern you, consider this – a variety of Middle East countries will find themselves way short of cash to keep their citizens happy, and do you care to imagine a Middle East that is less stable than now? My existence is too vanilla to even guess what that would look like, but I suspect a lot of explosions would be a cornerstone of any developments along those lines.

Oil producers get pretty beat up by falling prices, though it’s hard to feel sorry for them too much given the wealth they’ve been wallowing in for a while (that’s a dangerous generalization of course, some of the more bungling or incapable producers have merely been getting by). A lot of people do feel the pain though; as low oil prices cause a drop in cash flow for oil producers, they drill less, and that causes a large ripple effect through various business sectors that lose customers or revenue. But again, these industries are used to the ups and downs.

And finally, the biggest kick in the teeth is reserved for the environment (I was going to say Mother Nature but that didn’t sit quite right…). Solar and wind power became more economical relative to fossil fuels because oil and natural gas prices rose substantially over the past decade. As the price of oil or natural gas falls, the incentive to use either of those as fuel grows relative to solar and wind. Solar and wind costs have fallen a lot, but not enough to have a clear cost advantage.

On top of that, as oil and then gasoline prices fall, consumers seem to have very short memories and begin eyeing up monster SUVs and anything with a big motor. People drive more miles and get fewer mpg, so fuel consumption climbs again and Greenpeace pulls out its nested dreadlocked hair in frustration. At least they can take solace in the fact that oil sands projects are among the higher cost projects in the world and are thus vulnerable to low oil prices. That may be small consolation though when US oil consumption starts rising again…

I don’t mean to rain on anyone’s parade; go ahead and enjoy the cheaper fuel. It’s a rare situation where the average consumer gets a significant benefit that isn’t some sort of government subsidy or politically driven tax contraption. On the other hand, it’s good to think about some of the other global repercussions.