29 Jan/15

What Does Cheap Oil Mean For The World?

From the commodity trader to the end consumer filling up his gas tank on the way to work, everyone has noticed the recent and dramatic fall in the price of oil. From roughly 2010 until the middle of 2014, the average price for a barrel of Brent crude oil was $110. Recently, the average price dipped below $50, representing a fall of approximately 55% over the past 6-7 months. Naturally due to the connection between the price of oil and the price of gasoline, this means lower gas prices, which is bound to make end consumers happy. But what does this means for the individual economies of the world?

For oil production-based countries who have long been reliant on the profits of the energy industry, this rapid price fluctuation can be bad economic news, especially if mixed with a lack of fiscal planning. For example, countries who have relied on oil profits to bolster a spending plan, such as Venezuela and Nigeria, are already starting to face potential unrest as they are forced to choose between spending cuts or a combination of higher taxes and fewer subsidies. At the other end of the spectrum are countries like Saudi Arabia (and Russia, to a lesser degree and with extenuating circumstances), which has prepared for a downturn like this by establishing a reserve fund- estimated at $700 billion- that will enable them to maintain current levels of oil production for at least several years without harming their domestic economy of spending plans.

Normally, for oil consuming nations, lower petroleum prices would be completely welcomed; unfortunately, for many of the leading drivers of the global economy, it is their own weak economic situation that has been the cause of this reduction in oil prices. Both Chinese and EU-based consumers will benefit from lower fuel prices, but this comes with underlying problems. Chinese economic growth, which had been 10.4% and 9.3% in 2010 and 2011, respectively, is now expected to be less than 7% for 2015, which represents a significant slowing, while the EU is currently preparing a $60 billion-a-month quantitative easing program to stimulate Europe’s economy. As for the United States, who had been the world’s largest oil importer, domestic shale oil production has lessened American reliance on foreign energy and buffered the economy from oil shocks, but, though American seems to have recovered from the worst of the recent recession, a number of key factors, like the labor force participation rate, demonstrate that there is still a long path to reach true growth.

All things considered, the meaning of cheap oil for an economy is really about perspectives – it can be good news for private consumers as it could help to lower costs and bad news for the whole country in that it is the product of diminished spending and a slowing economy. Theoretically, it is suggested by the IMF that a $10 fall in the price of oil leads to 0.2% of global economic growth (accordingly, 2015 should see the global economy grow by approximately 1%). However, the IMF also recently revised global economic growth down by 0.3% to 3.5% in 2015. Unfortunately, it appears that economic weakness is trumping the appeal of cheap oil, and as soon as the drivers of the global economy recover, so will the price of oil.