[ 2014-12-16 ]

Winners and losers of oil price plunge
London (UK) – 16 Dec 2014 – FT - Suddenly the
world is awash with oil. A surprise surge in
production and weaker than expected global demand
for crude have sent oil reserves soaring and
prices tumbling. The 40 per cent drop in the oil
price to around $60 a barrel since June is by far
the biggest shock for the global economy this
year. Similar episodes in the past tell us the
consequences are likely to be both profound and
long lasting. Normally, economists would add
“positive” to this list, but doubts are
surfacing as never before.

The scale of the current oil shock is difficult to
exaggerate. While financial markets and
commentators were obsessed by rising geopolitical
tensions and the latest twists in central banks’
policies in the US, Europe and Japan, even larger
forces in oil markets went largely unnoticed. As
late as October, a “key concern” of the
International Monetary Fund was the risk of an oil
price spike caused by geopolitical tensions.
Instead, rising production and weaker demand
growth have left suppliers competing to find
willing customers.

Rich country stocks of crude oil have defied the
onset of the northern hemisphere winter and risen
to their highest level in two years, according to
the International Energy Agency. West Texas
Intermediate crude oil prices dropped from more
than $100 a barrel in June to less than $60, with
the European Brent oil prices following the same
downward path. Even a slight uptick yesterday
cannot disguise the downward trajectory of the
price.

Rather than geopolitical tensions in Ukraine and
Iraq causing an oil shortage and price spike, as
foreseen in the IMF scenario, the causality is
flowing from economics to politics. The plunge in
oil prices now threatens Russia’s living
standards and public finances to the point where
it will start 2015 as a devalued and belligerent
nation with nuclear weapons. In the Middle East,
the funds to finance vicious conflicts in Iraq and
Syria face greater pressures, which promise to
stretch all sides. And the US is less likely to
want to play global policeman now that it can
satisfy almost 90 per cent of its energy needs
from domestic sources, up from 70 per cent as
recently as 2005.

In normal times, the broad effects of the oil
price drop on the global economy are well known.
It should act as an international stimulus that
will nevertheless redistribute heavily from oil
producing countries to consumers and the longer
the new prices endure, the more profound will be
the effects on the structure of industries across
the world.

But this time, economists are actively debating
whether the world has changed and other moving
parts — such as falling inflation levels and the
strong dollar — will throw sand into the works
of the usual economic relationships.

But when oil prices fall, there is no iron law
that enhances global economic growth. The main
effect is a huge redistribution from oil
producers, who receive less for the effort of
extracting the black gold, to consumers who
benefit from cheaper transportation and energy,
enabling them to spend more money on other goods
and services or to save their windfall.

Most economists still agree with Christine
Lagarde, IMF managing director, who this month
said that “it is good news for the global
economy”. The positive effect on growth should
arise because oil consumers tend to spend more of
their gains than oil producers cut their
consumption.

Gabriel Sterne of Oxford Economics explains,
“producers have financial surpluses and don’t
tend to cut back, while lower prices redistribute
income to those who have a higher propensity to
consume and to invest”. The scale of the global
effect is significant. Oxford Economics estimates
that every $20 fall in the oil price increases
global growth by 0.4 per cent within two to three
years. The IMF’s core simulations suggest a
similar size of the effect, so the $40 reduction
in price would more than offset the total 0.5
percentage point downgrades to the IMF’s world
economic growth forecasts for 2014 to 2016 over
the past year. That boost is then amplified if it
generates a subsequent lift in confidence,
encouraging companies to invest and spend.

If the usual effect on the world economy is large,
it is always dwarfed by the swings that will
benefit some countries and hit others. The big
winners will be countries that are simultaneously
heavy users of energy and largely dependent on oil
imports. Moody’s, the credit rating agency,
calculates that countries “battling high
inflation and large oil subsidy bills, such as
Indonesia and India, will benefit most from a
lower price environment”.

Looking at 45 different economies, Oxford
Economics agrees that emerging economy oil
importers are likely to be the main winners. Most
advanced economies also gain significantly,
although as they have less dependence on oil for
every dollar of gross domestic product so their
proportionate gains are smaller. A further boon
for many emerging economies is that the fall in
fuel prices enables countries to cut fuel
subsidies, removing significant pressure from the
public finances. Lord Stern of the London School
of Economics says “this is exactly the right
moment to remove fossil fuel subsidies and
intensify carbon pricing”.

For oil exporters, however, the outlook is darker.
Those which have tended to spend rather than save
oil revenues have the least capacity to adjust to
the new reality. Moody’s estimates that Russia
and Venezuela will be hardest hit, since they have
“large recurring expenditure that may be
politically challenging to cut”. The largest oil
producer, Saudi Arabia, has much greater fiscal
buffers since it saved more than it spent.
Currency markets have already reacted brutally to
those countries it considers vulnerable, pushing
down the rouble 40 per cent against the dollar
over the past six months, for example.

So far, so normal. But this time there are more
voices than usual suggesting expectations of a
global boost are deceptive. Stephen King, chief
economist of HSBC, believes lacklustre demand in
China, Japan and Europe over the summer was the
primary cause of the collapse in prices so the
traditional “lower oil prices good: higher oil
prices bad” story is “no longer so obviously
true”.

He argues that optimism following an oil price
fall in economic estimations is based on positive
supply-side developments for the western developed
world, but “there are plenty of situations where
falling oil prices are merely symptoms of a wider
malaise”.
Deflation fears
Mr King argues that much of the past gains from
oil prices have come from lower interest rates
associated with falling inflation, which cannot
happen when monetary policy is already stimulating
economies as hard as it can. If households in
China, Europe and Japan feel there are reasons to
save any windfalls they receive, the global demand
boost will be severely restricted.

And one reason consumers might be less willing to
open their purses and wallets this time is that a
spectre of low inflation stalks many advanced
economies. While stable or falling prices make
people better off, they also potentially threaten
a prolonged period of stasis if households prefer
to “wait and see” before spending their
money.

That attitude, encouraged by the possibility of
lower prices tomorrow could encourage companies to
delay investment and households to put off
consumption, generating a self-fulfilling prophesy
of soggy growth and gently falling prices.

The threat is not to be dismissed lightly. Oxford
Economies estimates that with an oil price of $60
a barrel, 13 European countries will see their
inflation rates fall below zero, at least
temporarily, in 2015.

Aware of the danger that oil could create
persistent disappointment rather than a shot in
the arm, Peter Praet, chief economist of the
European Central Bank, said monetary policy in
Europe did not have the normal luxury of simply
assuming lower oil prices would boost incomes and
spending this time. “In these conditions
monetary policy needs to react,” he said.

Other reasons why the usual boost to demand might
be more muted include the sharply rising dollar,
which ensures that domestic oil prices outside the
US have not fallen by anything like the 40 per
cent headline figure.

Some clues regarding the validity of the new fears
are provided by history. In 1986, the oil price
more than halved after Opec failed to control
supply, triggering a global economic surge that
accelerated global growth to a peak of 4.6 per
cent in 1988, a rate that would not be achieved
again until 2000.

In 2008, acute weakness of global demand led to an
oil price decline from $133 to $40 a barrel, but
even with fears of deflation, cheaper oil helped
generate a rebound in growth in 2010.

History, then, is kind to the traditional view of
the potency of cheap oil in stimulating global
economy in good times and bad. But economists also
know that history has not been a good guide to
many economic trends over the past six years.

Though a global boost is more likely now than it
was, there is no guarantee cheap oil will cast the
magic spell this time that it always has in the
past.

Source - FT

... go Back