Why much cheaper oil isn’t all good news

After a week of turmoil, there was relief in the markets and for everyday investors yesterday. The FTSE 100 finished the week higher, giving a desperately needed fillip to the country’s depleted ISAs and pension pots; and the price of oil recovered a little. In the past, a rebound in the price of crude would have been seen as a blow, at least outside Scotland – but these days, we seem to have started cheering each time it goes up.

Why? Have we lost the plot, or is it right for the UK, paradoxically now a major net oil importer as a result of the demise of the North Sea industry, to hope for a stabilisation of the price of oil? The answer is that oil’s slump remains good news, on balance, for consumers and manufacturers. With oil production contributing far less than before to our GDP, the direct downside on that front is small.

But there are counterbalancing factors, reasons why it makes sense for the financial markets to worry, even if the ultra-pessimists are wrong.

So why is it different this time? There are five main reasons. The most interesting is that many analysts are worried about a looming energy and commodity debt crisis. Firms borrowed to invest, including for fracking and shale; but it seems that this credit could turn out to be the new subprime mortgages. The worry is that as the energy and commodities bubble continues to burst, a tidal wave of bad debt could engulf the financial system, in a repeat of the crisis of 2008.

We are right to more vigilant about such matters; and Wall Street has indeed started to write off hundreds of millions of dollars of bad debt already.

But the volume of credit at risk seems manageable this time around, especially given the amount of capital that financial institutions now hold. There will be lots more pain, though.

Another difference is that the UK – which now has a large current account deficit, which needs to be matched with capital inflows – has been relying extensively on recycled petrodollars. Buildings like the Shard have been financed in this way, and Canary Wharf, among many other assets, is now owned by the Qataris. Less cash sloshing around sovereign wealth funds means less money coming to the UK, and reduced capital expenditure. Add to that the growing fears about the values of London residential property and one gets an explosive combination.

Another reason for the panic is the nature of the current oil shock. One driver is reduced demand from China and some other emerging markets – so each time the price slides, investors and companies are reminded that global growth is fragile. China has become more important to Western imports, even if the UK still relies far more on other economies.

The slump in oil prices has also made the markets look at the prospects of further Fed tightening in a very different light: what was once priced in and even a reassuring sign of normalisation now looks, to them, like a worrying monetary tightening at the worst possible time. Much of this is special pleading by a bunch of cheap credit junkies, but it remains the case that it is increasing risk premiums across markets and asset classes.

UK markets have also become more dependent on energy and commodity firms, partly thanks to London’s attractiveness to global capital. The collapse in their value has thus dragged down the index through a mathematical effect. Therein lies the problem. The stock market slump, triggered by all of these factors, is bound to affect economic activity.

Global equities recovered a little yesterday but it would be foolish to assume that a bottom had been found. Even if it had, a prolonged 20pc or so slump in global equities would cut 0.60.9pc from world GDP after two years, according to modelling by Oxford Economics. Britain’s growth rate would also be lower than currently expected, despite the boost from cheaper petrol. Oxford Economics believes that all of this has raised the risk of world GDP growth in 2016 falling towards 2pc.

We shall see. I’m not as pessimistic as many market observers; we should not forget the advantages of cheaper oil. But it’s finely balanced, and investors are understandably jittery.

‘Each time the oil price slides, investors are reminded that growth is fragile’