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Oil: The Good, the Better, the Ugly

Oil: The Good, the Better, the Ugly thumbnail

Oil prices have fallen a long way this year. They might fall much further still.

Crude prices have fallen 36% since their summer peak, then sent into a tailspin by  the failure of OPEC, the cartel of oil producing countries accounting for 40% of global supply, to trim its output quotas. And history suggests prices can fall substantially further.

It’s worth bearing in mind that for nearly two decades to 2005, crude oil prices largely ranged between $20 and $40 a barrel in today’s money. The average inflation-adjusted price of West Texas Intermediate oil since 1970 is a little under $55 a barrel compared with a little under $70 now.

That’s not to say that’s how far they’ll drop.

A rapid technical snap-back is always a possibility. But the fundamentals seem stacked towards lower rather than higher prices for now.

Which will make for some interesting economic dynamics.

Current lower gasoline prices relative to the average of the past three years will in effect put an extra $108 billion into U.S. consumers’ pockets, according to estimates by James Hamilton at the University of California, San Diego. That’s almost a 0.8% bump in disposable personal income.

Of course, what American consumers gain from, American producers lose out on. And with energy imports making up just 15% or so of U.S. consumption, according to the World Bank, the net effect on the economy would be slightly more modest.

But consider the impact of falling oil on that other major bear story, the eurozone.

It imports about 50% of its energy use–even though the per person intensity of energy consumption is less than in the U.S.

The drop in oil prices raises another dynamic here, however. Eurozone consumer price inflation has been running a mere 0.3% a year–so close to outright deflation that it’s panicking the European Central Bank. The drop in energy prices will put even more downward pressure on inflation.

ECB President Mario Draghi could well then use the falling inflation rate to call for even more aggressive monetary measures, not least outright purchases of eurozone sovereign debt. At the same time, he’d know falling energy prices would produce a fillip to the underlying economy. In other words, the slump in oil prices potentially represents a political as well as an economic windfall for the ECB.

The flip side of the eurozone’s gains from falling oil prices is, once again, the losses to oil producers. At first sight, this might appear to be a wash for the global economy. Except it’s not.

Oil revenues tend to be concentrated in the hands of a wealthy few. Increases in oil revenues don’t cause them to boost consumption by much. By the same token, falls shouldn’t result in major drops in consumption either. On the other hand, oil consumers tend to be relatively less wealthy with relatively higher propensities to spend. So the pass-through of falling oil prices is on balance positive for the global economy–it increases aggregate demand.

What the oil wealthy do, however, is reinvest their surplus into the likes of expensive art, London property and other luxuries. So, ironically, while falling oil prices might represent a boost to global growth, they might not be so favorable to some of the world’s more inflated asset classes.


8 Comments on "Oil: The Good, the Better, the Ugly"

  1. Makati1 on Fri, 28th Nov 2014 6:59 pm 

    Chaos is the new growth industry and is on track to set new records in 2015.

  2. JuanP on Fri, 28th Nov 2014 7:10 pm 

    I don’t see any winners in this oil price drop.

    Even countries like Uruguay, that imports 100% of the oil we use, will hardly benefit. It is very likely that this oil price crash will end up causing a global recession at some point. Uruguay may enjoy cheaper oil imports for a while, but its export income will suffer in the coming recession. The balance is likely to be negative for most of the world.

  3. Pveroi on Fri, 28th Nov 2014 7:52 pm 

    “The balance is likely to be negative for most of the world.” Isn’t that the point? Comparative advantage goes to the US. Very useful during a time when both Africa and Asia have yet to be cut up for their shale.

  4. Makati1 on Sat, 29th Nov 2014 2:28 am 

    Pveroi, how do you see this as an advantage to the US? If the prices drop more and hold for a few years, the shale industry will be over. The bubble popped, maybe forever. That will likely take down the US economy and make the Great Depression seem like a minor inconvenience.

    Some believe that if the US fails it will automatically take down the rest of the world. More American arrogance, I think. It may reduce the overall world economy some, but the rest of the world is moving away from the US quickly, both in currency and in trade.

    The US is getting poorer and the demand for imports is slowing. After all, it is only 4% of the world’s population and is shrinking economically and numerically. The 1/100% wants to take down what is left of the middle class. Seems to be happening quickly if you look close. This could be the final nail in the middle class coffin. We shall see.

  5. Kenz300 on Sat, 29th Nov 2014 8:48 am 

    Lower oil prices will help the European economy…….

    Lower oil prices will help most consumer economies recover faster from the effects of the Great Recession………

    Lower oil prices will help to raise GDP, raise demand and ultimately lead to higher oil prices.

  6. Pveroi on Sat, 29th Nov 2014 11:51 am 

    @mak. Not advantage but comparative advantage. US corps now in best position to develop Africa and Asia. Watch how many deals come up in the next couple months after new year. Once development starts in these places price will spike back up.

    Just my take.

  7. Dredd on Sat, 29th Nov 2014 12:52 pm 

    Will low oil prices cause an ice age so we can all get naked (Phases Of An Empire Freezing To Death – 2)?

  8. nemteck on Sat, 29th Nov 2014 3:35 pm 

    “…. American producers lose out on. And with energy imports making up just 15% or so of U.S. consumption ….”. Sloppy thinking here since future events are compared to present oil imports. If US producers lose and shut down then oil imports will rise.

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