The sudden fall in the price of oil has significant macroeconomic implications. It definitely means lower fuel prices for the general consumer but it will drastically reduce the revenue of countries that are exporting oil.
Is cheap oil good or bad for the economy?
Consumers are quick to welcome low oil prices but its global impact is challenging to understand. Many nations depend on oil as a major source of revenue and lower primes would adversely affect their economy. Low oil prices could signify a weak global economy which would overshadow most benefits of lower prices.
In the word of Arthur Berman, “The current situation with oil price is really very simple. Demand is down because of a high price for too long. Supply is up because of U.S. shale oil and the return of Libya’s production. Decreased demand and increased supply equals low price.” Is he right?
Supply and demand factors meant commodity prices were “likely to stay low for a sustained period” said Christine Lagarde, chief of the International Monetary Fund (IMF).
World leaders discuss how to deal with the drop in oil prices
A third of the world’s oil supply is controlled by the cartel, Opec. It meets two times a year, but during a winter December meeting Saudi Arabia and Iran had a standoff over production targets which led to a cold termination of the discussions. The 13-member cartel had said that it would agree on lower production targets if non-Opec states such as Russia also signed up to decrease their record output.
Significantly the market still continues to trade oil up in hopes that they can cut exports from oil producing nations from their multi-year profits. There were also reports that several members of Opec and Russia, the main non-Opec oil power, met to discuss corresponding actions but Saudi Arabia was not part of this meeting even though it is the largest producer and de facto leader of the cartel. This undermines the effectiveness of any agreement. Then there is the estimate in the report for the hitherto resistant domestic shale oil supply to show a more substantial drop this year (by 620,000). This would more than counter-weigh the half million barrels Iran is expected to supplement to the market and would instigate a rebalance of excess supply.
How has this affected countries across the globe?
Russia has been adversely affected by the plunge in oil prices. Its oil revenue make up for 50% of its budget revenue and about 70% of its export revenue. As the prices dropped, the country incurred an estimated loss of two billion dollars in revenue (per dollar fall in pricing). This has caused the Ruble to fall which required the central bank to raise the interest rates and sell the foreign currency reserves to support the currency. The Russians require oil prices to be above hundred and five dollars a barrel to stabilize its budget. Market conditions will either cause the government to run deficits or force it to cut down on other programs, key to the country’s economic growth.
In Saudi Arabia, the government is highly dependent on the oil revenue as it makes up for ninety percent of the government’s revenue. The fall in prices would lead the government to run a budget deficit and may also lower its expenses. It will upset job creation in the country as most of the jobs available are based on government contracts. Even though the short term reduction in revenue won’t be an issue as they can just sink into their seven hundred billion dollar sovereign wealth funds. The main reason for not cutting their oil production is also political, the lower the prices decline, shale oil production in US will feel the brunt of it.
A giant beneficiary of the oil prices slopping downwards is the United States. It is the second largest importer as well as the second largest producer of oil. Oil production in US has been increasing considerably over the past 5 years due to the use of methods like fracking. Lower oil prices will adversely affect the viability of US energy companies such as Chevron, Exxon, etc.
Investment bank bears warn that Oil could crash to $10 a barrel.
“Given that no fundamental relationship is currently driving the oil market towards any stability, prices are being moved almost entirely by financial flows caused by fluctuations in other asset prices, including the dollar and equity markets,” – Standard Chartered. It joined the likes of Goldman Sachs, Morgan Stanley and RBS as it lowered its oil outlook to $10. Simon Williams told that, “A $10 world would lead to petrol prices falling back to 86p-per-litre”.
The present-day mayhem has created a once-in-a-generation break for shrewd energy investors in the market. As the conventional media prints scary stories of oil prices falling through the floor, the smart investors are setting up their subsequent winning oil-plays.