When prices rise sharply, they will also decline sharply. A long period of high prices is followed by a long period of low prices. This is the major lesson that Russian market participants and policymakers should relearn.

A pump jack is seen at sunrise near Bakersfield, California, October 14, 2014. Photo: AP

After OPEC met on Nov. 27, the price of oil continued its abrupt slide, since June, toward the $70 per barrel level, losing more than a third of its value in the process. OPEC’s key member and the world’s swing oil producer, Saudi Arabia, clearly indicated market share is more important at this point than an unsustainably high oil price that can only be maintained by cutting Saudi production (but without the cooperation of other major producers, such as Russia). Under conditions of abundant supply and slow-growing demand, oil prices will be under downward pressure through the first half of 2015, before a floor can be established.

With almost four years of oil prices hovering above $100, it was easy to be fooled to believe that this historically high level is the new normal. Yet in 2007 oil prices started below $60 before a commodity price bubble ballooned the price to $140 in the summer of 2008, only to burst six months later by dropping $100 in price. It seems market participants and policymakers, who should all know better, must relearn the lessons of oil price cycles every decade or so. When prices rise sharply, they will also decline sharply. A long period of high prices is followed by a long period of low prices.

The reasons are simple. The petroleum industry is characterized by price inelasticity in the short term, given the long lead-time for investment to increase production and decrease demand, but is responsive to pricing in the medium to long term. We saw this in the oil price spikes of the 1970s, which were followed by soft prices from the mid 1980s to the late 1990s.

In the oil world, low prices follow high prices as surely as night follows day. The $100 oil of recent years, driven by political uncertainty, not fundamental supply and demand, was never in OPEC’s long-term interest as it encourages conservation, fuel substitution, investment in alternative supplies, and innovation. The American unconventional oil and gas revolution is merely the latest example of a pattern repeated over more than 150 years.

With long reserve lives for the cheapest oil to produce, OPEC countries only benefit producers with short reserve lives for high-cost oil, such as those in America or Russia, when they prop up prices. Saudi Arabia is no longer going to cut production in order to benefit others, who are not willing to cut their own production, and harm long-term Saudi interest for the sake of artificially high oil prices. It has learned the lessons of past price cycles, but has others?

Given Russia’s recent history and current dependence on oil income for its economy and national budget, it is amazingly unprepared for a cyclical drop in oil prices. Indeed it appears to have taken for granted high prices in formulating its domestic and external policies. A prudent government takes advantage of high oil prices by conserving the temporary windfall and by investing in human capital development and economic diversification for sustainable growth.

An imprudent government assumes high oil prices will last and go higher still, and misuses the windfall to avoid needed reforms. It may even engage in foreign adventures and imperial overreach in part because it overestimates its capabilities, appeal and stature. Usually the country ends up worse off after the high price period than it was before. Examples of this resource curse, which is really a problem of poor governance, abound in the oil and gas world.

The clear winners in the steep drop in oil prices are large oil consumers and importers, such as China, the U.S., Europe, and Japan, who also suffered when prices were high and volatile during the last four years. Their economies will improve and populations benefit from lower oil prices. If they are wise, they will also use the opportunity and extra funds to restructure their own economies and to lessen their dependence on fossil fuels. Even more important is the benefit lower oil prices have for the more than one billion people in the world who do not have access to commercial energy, such as electricity and cooking fuel. The poor will benefit from lower prices by gaining better access to energy.

The impact of lower oil prices on American unconventional oil and gas production is commonly misunderstood. The shale revolution was obviously driven by high prices. However, once technological innovation takes hold, it continues to advance, in this case, by increasing the resource base multifold and improving recovery rates and efficiency. Natural gas prices in the U.S. are now at a third of its peak level, yet shale gas production continues to increase. Similar cost reductions will occur in tight oil or shale oil, which is just at the beginning of the learning curve. Lower oil prices will certainly slow investment and, therefore, production increases, but it will not cancel the shale revolution.

The opinion of the authors may not necessarily reflect the position of Russia Direct or its staff.