What will oil price slump mean for the global economy?

The current oil rout is now worse than any since 1970, with the price of Brent crude slumping from $US115 a barrel in the northern summer of 2014 to an 11-year low beneath $US32 in recent days.

The slump has roiled global financial markets, and oil exporters. But for many of us, cheaper oil is a good thing.

The rise in the oil price is lifting hopes among equity investors that the economy will stave off the threat of deflation.
The rise in the oil price is lifting hopes among equity investors that the economy will stave off the threat of deflation. Photo: Bloomberg

However, the strain of cheap crude is beginning to mount. Who will the winners and losers be if oil prices stay low?

Why are oil prices falling?

Commodity prices, like most others, are determined by two factors: supply and demand.

The longer-term oil price sell-off has been led by a rise in supply, as US production has picked up with the advent of shale gas investment on a large scale. More recently, the failure of oil cartel Opec last month to agree to new production ceilings signalled that exporters still aren't sure how to deal with lower prices.

Meanwhile, crude demand has faltered as China, the world's second-largest economy, pivots away from energy-intensive industrial growth, towards a more consumption-led model of development. That has come amid signs of weakness in emerging markets, indicating that demand for oil will be lower.


Will crude prices keep falling?

A number of potential catalysts could drive oil yet lower. Some analysts have said that $US20 a barrel is now not out of the question, or even below that. Many China watchers believe that Beijing could allow a further weakening, or even attempt a devaluation of, the yuan. Recent warm weather, along with forecasts of more to come, should also mean there is less demand for oil.

Oil supply may also be set to rise, as Iran attempts to hit its targets, and US shale is resilient. Even if US shale production does not grow, but simply avoids decline, that would be negative for oil. A combination of these factors could mean that oil prices fall further.

Who has suffered with prices so low?

Many oil exporters have already been put under pressure by the slump in prices. Among them, Russia and Latin American countries such as Venezuela, Colombia, and Ecuador.

Vladimir Putin, Russia's president, last month insisted that the country's economic crisis had peaked, despite being "hugely dependent" on global factors such as the oil price. Analysts have criticised Moscow's officials for failing to diversify the economy, which does little else than "facilitate rent extraction". Gulf states have also come under strain, with Saudi Arabia unveiling a record budget deficit of 367 billion riyals ($140 billion) for last year.

Bank of America Merrill Lynch economists said that the oil price slump meant that "the era of [Saudi's] material overspending is likely firmly behind us".

Analysts at Deutsche Bank said that "history shows the potential for geopolitical tensions in the Middle East to push oil prices higher", and the possibility of instability in the region could interrupt production. Low prices themselves could provide a catalyst, as cheap oil undermines the outlook of Middle East economies.

How much pain is in store for the developed world?

High-profile victims to date have all been in emerging markets. While cheap oil has been painful for some sectors in developed economies, this has been counteracted by the benefits reaped by consumers. Low oil prices have kept inflation close to zero, acting as an effective tax cut for many.

However, analysts have warned that prices could now be approaching an inflection point for the US economy, where many oil producers could be at risk of default. Danske Bank described crude price declines as a "risk to the US economy", as low prices put pressure on the oil sector. While oil investment makes up just 1 per cent of US GDP, declines last year dragged GDP down 0.4 percentage points.

Analysts at the Danish bank believe weak oil could pull down US GDP again this year. Bankruptcies in the sector in the second half of last year exceeded the levels witnessed during the financial crisis, according to Bank of America, as low prices have resulted in a "huge reduction" in investment.

While the negative impacts of oil arrive immediately, the positive effects take longer to materialise. While oil might act as a depressant for now, it will become a stimulant later. For eurozone countries, the outlook is much rosier. The German bank believes that the renewed oil sell-off could add to growth for euro area economies across 2016. It looks like cheap oil will help the currency bloc yet again.

The Daily Telegraph, London

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