Oil’s fragile balance

At the climate change summit in Paris, delegates agreed on the goal of a carbonfree future. For now, however, oil retains its power to shock, both positively and negatively. Yesterday, the oil price sank to a new 11-year low. This is – on balance – good news for big consumer nations, though not unequivocally so for Britain, which also remains a not inconsiderable producer.

Yet for the rest of the economy, low oil prices are a stimulus; it puts more money in people’s pockets for spending on other things and, by pressing down on inflation, provides a further boost to real-wage growth. We should enjoy it while we can, for it is unlikely to last. When the turn comes, it may be violent and its consequences unpredictable.

As things stand, the falling oil price is driven not by weak demand – in fact, global demand has grown over the past year – but abundant supply. Saudi Arabian determination to defend market share against the onslaught of American shale has seen the kingdom abandon its traditional position as a swing producer, and carry on producing at full throttle. There may be other, ulterior motives. Depressed oil prices are likely to inflict far more damage on Iran and Russia than they do on Saudi itself. Ironically, the US is therefore perfectly happy to go along with Saudi brinkmanship.

It is a huge gamble on Saudi’s part, which hasn’t yet succeeded in dislodging high-cost American shale. This apparent glut in supply, however, means that the amount of spare production capacity globally is quite small. It would therefore require only a relatively minor disruption to supply for the situation to reverse and prices to rocket. Rarely have both the geopolitics and economics of oil looked so fragile.