Fall in oil prices has failed to produce theoretical economic fillip

For my friend and former geologist colleague who lost his job with a large Canadian company last week, low oil prices are not the welcome boost to economic growth that theory predicts. Of the US’s 11 post-war recessions, 10 were associated with a significant rise in the oil price, according to economist James Hamilton. Yet the relationship does not necessarily work in reverse: the sharp drop in prices since the middle of 2014 seems to be having paradoxically negative effects, even beyond the petroleum industry.

Overall, conventional wisdom has it that a fall in oil prices hands spending power to consumers, like a tax cut, and boosts global economic growth. But in January, stock markets and the oil price moved almost together – as worries about the Chinese economy drove fears over oil demand.

Obviously, lower oil prices have an immediate negative effect on oil-producing regions. Brazil, Mexico and Colombia have raised interest rates, Azerbaijan is suffering protests over the deteriorating economy, the Kazakh and Russian currencies have plummeted, and even the GCC countries are slashing their budgets and thinking of privatisation programmes.


Among the worst-performing US state economies in 2015 were the big oil and gas producers Texas, Alaska, North Dakota, New Mexico, Wyoming and Oklahoma.

A wave of defaults from commodity producers is possible, as I suggested back in October. Countries, such as Nigeria, Angola and Venezuela, and companies, such as the US shale driller Chesapeake or Brazil’s national champion Petrobras, all look vulnerable. The energy sector does not have the systemic importance of the big banks during the 2008 credit crisis, but the circle of losses could still widen.

The effect of lower oil prices ripples throughout the economy: the petroleum industry is a major consumer of energy itself, as well as of steel, cement, transportation and a host of ancillary services. US investment in energy passed 10 per cent of the country’s total investment during the boom years; now it has fallen below 6 per cent.

The global oil industry lost more than 250,000 jobs last year, 100,000 of which were said to be in Canada. Oil companies are not very large employers, but these roles were highly-paid, supporting other jobs indirectly.

JP Morgan has forecast that the big oil-backed sovereign wealth funds could sell US$75 billion of shares this year to support government budgets, though this would still be a negligible share of a global market capitalised at some $38 trillion. Prime London real estate has faltered, perhaps with less buying power from wealthy Russian, Nigerian and Gulf investors.

Compared to this rapid impact, it takes longer for motorists to spend their savings at the pump on consumer goods, when the outlook is uncertain and they are still paying down debts. Cuts to energy subsidies in China, Indonesia and the Middle East mean that the end-user may see prices flat or rising, rather than falling.

Lower energy costs reduce inflation and, with the Eurozone, Japan, Switzerland and perhaps even the US setting zero or negative interest rates, there is not much more room for monetary policy to avoid deflation. The positive effect on China of a reduced oil import bill is outweighed by its overall slowdown, and the gyrations in its stock market and currency.

It might seem that, a year and a half into the price slump, there should have been time for the beneficial effects of cheap energy to work their magic. Indeed, the outlook for energy importers such as the UK, Germany, Spain, India, Pakistan and Bangladesh has escaped the general malaise. But most other big economies are either energy producers, or the boost from cheap oil is not enough to overcome the drag from their other problems. Optimists looking for a way out of the oil slump will have to find a glimmer of hope elsewhere.

Robin Mills is CEO of Qamar Energy, and author of The Myth of the Oil Crisis

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