Oil prices and global growth

Financial Mirror (Cyprus) - - FRONT PAGE -

The good news is that this wel­come but mod­est ef­fect on growth prob­a­bly will not die out in 2016. The bad news is that low prices will place even greater strains on the main oil-ex­port­ing coun­tries.

The re­cent de­cline in oil prices is on par with the sup­ply-driven drop in 1985-1986, when OPEC mem­bers (read: Saudi Ara­bia) de­cided to re­verse sup­ply cuts to re­gain mar­ket share. It is also com­pa­ra­ble to the de­mand-driven col­lapse in 2008-2009, fol­low­ing the global fi­nan­cial cri­sis. To the ex­tent that de­mand fac­tors drive an oil-price drop, one would not ex­pect a ma­jor pos­i­tive im­pact; the oil price is more of an au­to­matic sta­biliser than an ex­oge­nous force driv­ing the global econ­omy. Sup­ply shocks, on the other hand, ought pos­i­tive im­pact.

Al­though pars­ing the 2014-2015 oil-price shock is not as straight­for­ward as in the two pre­vi­ous episodes, the driv­ing forces seem to be roughly evenly split be­tween de­mand and sup­ply fac­tors. Cer­tainly, a slow­ing China that is re­bal­anc­ing to­ward do­mes­tic consumption has put a damper on all global com­mod­ity prices, with metal in­dices also fall­ing sharply in 2015. (Gold prices, for ex­am­ple, at $1,050 per ounce at the end of Novem­ber, are far off their peak of nearly $1,890 in Septem­ber 2011, and cop­per prices have fallen al­most as much since 2011.)

New sources of oil sup­ply, how­ever, have been at least as im­por­tant. Thanks to the shale-en­ergy revo­lu­tion, Amer­i­can oil pro­duc­tion has risen from 5 mln bar­rels per day in 2008 to 9.3 mln bar­rels in 2015, a sup­ply boom that has so far per­sisted, de­spite the price col­lapse. An­tic­i­pa­tion of post­sanc­tions Ira­nian oil pro­duc­tion has also af­fected mar­kets.

A de­cline in oil prices is to some ex­tent a zero-sum game, with pro­duc­ers los­ing and con­sumers gain­ing. The usual think­ing is that lower prices stim­u­late global de­mand, be­cause con­sumers are likely to spend most of the wind­fall, whereas pro­duc­ers typ­i­cally ad­just by cut­ting back sav­ings.

In 2015, though, this be­hav­ioral dif­fer­ence has been less pro­nounced than usual. One rea­son is that emerg­ing-mar­ket en­ergy im­porters have a much larger global eco­nomic foot­print than they did in the 1980s, and their ap­proach to oil mar­kets is




sig­nif­i­cant much more in­ter­ven­tion­ist ad­vanced coun­tries.

Coun­tries such as In­dia and China sta­bilise re­tail en­ergy mar­kets through gov­ern­ment-fi­nanced sub­si­dies to keep price down for con­sumers. The costs of th­ese sub­si­dies had be­come quite mas­sive as oil prices peaked, and many coun­tries were al­ready look­ing hard for ways to cut back. Thus, as oil prices have fallen, emerg­ing­mar­ket gov­ern­ments have taken ad­van­tage of the op­por­tu­nity to re­duce the fis­cal sub­si­dies. At the same time, many oil ex­porters are be­ing forced to scale back ex­pen­di­ture plans in the face of sharply fall­ing rev­enues. Even Saudi Ara­bia, de­spite its vast oil and fi­nan­cial re­serves, has come un­der strain, owing to a rapidly ris­ing pop­u­la­tion and higher mil­i­tary spend­ing as­so­ci­ated with con­flicts in the Mid­dle East.

The muted ef­fect of oil prices on global growth should not have come as a com­plete sur­prise. Aca­demic re­search has been point­ing in this di­rec­tion for a long time. Oil is now thought to be less of an in­de­pen­dent driver of busi­ness cy­cles than was pre­vi­ously be­lieved. Also re­strain­ing growth is a sharp de­cline in en­ergy-re­lated in­vest­ment. Af­ter years of rapid growth, global in­vest­ment in oil pro­duc­tion and ex­plo­ration has fallen by $150 bln in 2015. Even­tu­ally, this will feed back into prices, but only slowly and grad­u­ally: Fu­tures mar­kets have oil prices ris­ing to $60 per bar­rel only by 2020.

The good news for 2016 is that most macroe­co­nomic mod­els sug­gest that the im­pact of lower oil prices on growth tends to



the stretch out for a couple years. Thus, low prices should con­tinue to sup­port growth, even if emerg­ing-mar­ket im­porters con­tinue to use the sav­ings to cut sub­si­dies.

For oil pro­duc­ers, though, the risks are ris­ing. Only a couple – no­tably gov­er­nancechal­lenged Venezuela – are in out­right col­lapse; but many are tee­ter­ing on the brink of re­ces­sion. Coun­tries with float­ing ex­change rates, in­clud­ing Colom­bia, Mex­ico, and Rus­sia, have man­aged to ad­just so far, de­spite fac­ing sig­nif­i­cantly tighter fis­cal con­straints (though Rus­sia’s sit­u­a­tion re­mains es­pe­cially vul­ner­a­ble if low oil prices en­dure). By con­trast, coun­tries with rigid ex­change-rate regimes are be­ing tested more se­verely. Saudi Ara­bia’s long-stand­ing peg to the dol­lar, once ap­par­ently in­vul­ner­a­ble, has come un­der enor­mous pres­sure in re­cent weeks.

In short, oil prices were not quite as con­se­quen­tial for global growth in 2015 as seemed likely at the be­gin­ning of the year. And strong re­serve po­si­tions and rel­a­tively con­ser­va­tive macroe­co­nomic poli­cies have en­abled most ma­jor pro­duc­ers to weather enor­mous fis­cal stress so far, with­out fall­ing into cri­sis. But next year could be dif­fer­ent, and not in a good way – es­pe­cially for pro­duc­ers.

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