Connect with us

Commodities

Oil Mania: The Winners & Losers

 5 min read / 

The recent glut in oil prices is due to both increased supply from the US, OPEC and subdued demand, especially from China and Europe. The reluctance of OPEC to lower oil production levels and the growth of shale oil have been the concentration of recent media focus. However, when evaluating the future price of oil, demand is more important as supply is unlikely to be the determining factor in oil’s price movements. A report from Goldman Sachs announced that the decrease in oil price threatens almost $1 trillion worth of expenditure on oil projects. Thus, a reduction in oil output increases is to be expected. The International Energy Agency cut its forecast for 2015 oil demand growth by 230,000 barrels a day – its fifth downward revision in six months. This leads to the conclusion that the price of oil is set to settle well below OPEC’s $90 target. As the most likely outcome, I will discuss the economic impacts of such a scenario.

To assess the economic impacts, I have divided countries into four categories through the following two criteria: their economic inflation status and whether they are a net importer or exporter of oil.

Healthy inflation & net exporter of oil

Examples: The USA, Saudi Arabia, Nigeria and Qatar

The majority of these economies are significantly dependent on energy resources. In Saudi Arabia and Nigeria, revenue from oil accounts for 80 and 70 percent of government revenues respectively. Even in the USA, a developed country with a prominent financial sector, derivatives related to fracking constitute 20% of the US derivatives market. Furthermore, junk bonds and leveraged loans that funded small American fracking companies’ growth face the prospect of defaults due to challenged profitability. Considering these energy companies issued 14% of all junk bonds sold in October, the degree of possible contagion within the US economy is significant.

However, within this category, the countries with stable governments tend to have strong domestic demand. This allows their economies to benefit from cheaper production costs and increased real income. It is also likely that these countries have developed sovereign wealth funds from previous oil revenue. Due to this, governments could extract the necessary funds to maintain government expenditure in the short run.

Healthy inflation & net importer of oil

Examples: Japan, India and United Kingdom 

These countries are set to benefit the most, assuming healthy inflation is an indicator of a healthy economy. The decrease in the price of oil acts as a tax break for consumers and producers. The subsequent increase in real incomes and consumption will support domestic demand. This is important for these countries, as their export markets face the challenge of subdued domestic demand within China and the EU.

Unhealthy inflation & net exporter of oil

Examples: Venezuela, Russia and Libya

These countries’ oil industries (and closely related industries) constitute a significant proportion of their GDP. They also tend to be less politically and/or economically stable than countries in the first category. Therefore, they are set to be the worst affected by oil price decreases. As speculators and investors sell holdings of these countries’ currencies and capital flight increases by value, the abnormal inflationary pressures are set to increase with decreasing economic confidence. This will be to the detriment of economies that are already in a poor state, making it harder for them to emerge from economic turmoil.

Unhealthy inflation & net importer of oil 

Examples: The EU, China, South Korea, Singapore

Again, these oil-importing countries benefit from higher real incomes. However, this positive may be negated through the disinflationary pressures added to already low inflation environments. Extremely low inflation combined with low domestic demand act as disincentives to future investment and consumption regardless of shifts in real incomes. This limits the potential extent of economic growth.

To prevent the occurrence of deflation, central banks in these countries may opt to undertake/expand their quantitative easing programs and/or adopt a loose fiscal expenditure in order to maintain confidence in their economies. This support reduces the possibility of deflation occurring.

Oxford Economics estimates that every $20 fall in the oil price increases global growth by 0.4% within two to three years. Furthermore, oil consumers spend more of their gains than oil producers cut their consumption. This implies that drivers of this increased global economic growth will be from net oil importing countries.

Out of the four groups, the outcome for three appears to be between neutral and positive. If the knock-on effects of individual economies’ growth are considered, there exists ancillary benefits for other economies. An example being China. If its economy realised increased domestic demand then countries exporting electronic equipment, oil and machinery would benefit. As China is Germany’s third largest export destination, this will provide incentive for the German car industry to invest and increase output. Economic consequences can be extrapolated in this manner to show an inverse domino effect. Wherein one economy rises, another will rise.

A quick reference to history must be noted; when oil prices sunk to $10 in 1986, due to OPEC increasing supply to regain market share, global economic growth accelerated to maximums of 4.658% in 1988 – a growth rate yet to be reached again. To conclude, this new reduced equilibrium for oil, despite the negatives spewed across the media, may in fact be a blessing in disguise.

Sign up to Mogul News.

Click to comment

Leave a Reply

Your email address will not be published. Required fields are marked *

Send this to a friend