Predicting the global impact of plummeting oil prices depends on many interrelated factors. But one important pointer is whether the oil price is falling due to oversupply or weak demand. Today’s fall is driven by both. This is why it is confusing and alarming at the same time.
It is alarming because falling oil prices add to deflationary pressures in the major economies at a time when important drivers of global growth – big emerging markets – are slowing. Volatility in financial markets is another problem reflecting investor jitters about the energy sector: the biggest corporate borrowers in emerging markets are in the oil sector – such as Brazil’s Petrobras – and the US junk bond market has a significant share of highly indebted shale producers.
It is confusing because economists suggest lower oil prices should give a boost to global growth – by 0.5 per cent in 2016 with oil at $60-70 a barrel. This is due to an expected net increase in global demand as oil importers are able to consume more. But the boost to growth is not yet evident, for several reasons:
- Many advanced economies are still reducing debt and consumers seem to be in saving mode, though this could change. US data for 2015 show higher consumption of the windfall in gas-guzzling states.
- In oil-importing emerging markets, the oil price decline is not being fully passed on.
- Adding to the weakness in global demand, oil exporters, such as in the Gulf, are cutting budget spending that has been a source of vital stimulus to the global economy since the financial crisis.
- Postponed investments in the energy complex and supporting industries are also having an impact on growth.
Some oil-importing emerging markets have benefited from lower energy prices, including India and Turkey, with the former showing one of the highest GDP growth rates in 2015. Developing countries with big agricultural sectors also benefit from lower fuel costs and food prices, which boost real incomes. But these gains are not enough to offset the global negatives.
Changes in the structure of the global economy are also important factors. Energy efficiencies, and the relative decline of energy-intensive sectors in the global economy, are a long-term trend that dampens the impact of high oil prices. This trend was already noted when the soaring cost of oil from the mid-2000s failed to dent growth.
The broader effects of oil price movements also need to be considered.
The rise of OPEC and the tripling of the oil price in the 1970s not only contributed to the mid-1970s recession. High oil prices also fuelled inflation in the United States, leading to a sharp rise in interest rates, which combined to trigger a wave of sovereign defaults in the early 1980s that undermined growth prospects in Latin America for almost a decade.
The long-running oil price decline from the late 1980s (to a low of $15 a barrel) contributed to the collapse of the Soviet Union, which could no longer carry the financial burden of its satellite states.
Conversely the rise in oil prices in the past decade encouraged the switch to new oil technologies including the shale oil industry that has transformed the US from being a major oil importer to an exporter.
Today we are at another inflection point. With the power of OPEC waning, most of the oil price decline could persist. This is bad news for the main oil producers with already fragile economies such as Iran, Russia, Nigeria and Venezuela. The latter is only avoiding outright default with Chinese assistance.
Some economies such as Saudi Arabia and Colombia have built up their foreign currency reserves to cushion the shock. But others, such as Nigeria, did not and are likely to follow Azerbaijan, which recently began discussions on an IMF loan. The good news is that some countries have initiated major reforms to try to lift the ‘oil curse’. But this process is likely to involve wrenching structural reforms, possible defaults, and political instability.
All this increases risks especially in the Middle East. In the 1960s, the Gulf’s central position in the oil market brought about a new regional power balance, with the US in the role of security guarantor.
These regional parameters are now shifting. Post-Iraq, the US seems unable or unwilling to engage; colonial-era borders are under threat; and regional powers – Saudi Arabia, Iran, Turkey, and Russia – are trying to fill the power vacuum.
Saudi Arabia’s seemingly straightforward tactic to protect its share of the oil market also meets the needs of a strategic goal: to check the power of regional rivals. The current flux in the global energy market brings much uncertainty and geostrategic risk. No wonder financial markets are jittery.