Oil price loss is a gain!

16th December 2014

Ian Copelin, Investment Director, my wealth comments “This morning the global price of crude oil fell below $60 a barrel for the first time in five years – and has now fallen 47% since 24 June when it traded at $112 a barrel.

Surprisingly, the equity markets have also weakened, interpreting the drop in the oil price is a worrying sign of weakness in the global economy.  Whilst global economic growth has been subpar, in my opinion it is not weakening.

The decline has been led by OPEC’s (the Organization of Petroleum Exporting Countries) decision to maintain its daily production of 30 million barrels of oil a day and defend its near 40% market share despite the US shale revolution, which has resulted in US oil output doubling over the past couple of years to just over 9 million barrels a day.

While the sharp drop in the oil price isn’t good for those who produce it, it is a huge positive for oil consumers:  rising oil prices have historically been associated with recessions and falling oil prices with economic growth.  And Goldman Sachs recently estimated that US consumers could be around $100 – $125 billion better off as a result of the recent fall in the oil price.

Japan and Europe along with many emerging markets (such as India and China) will also get a boost from cheaper oil.  Japan, for example, since the Fukushima nuclear disaster, imports almost all its energy.

During a speech in New York, George Osborne, the Chancellor of the Exchequer, yesterday said the fall in oil prices will on balance be ‘a net positive’ in respect of the UK – although the government will see a drop in revenues from the North Sea, it will benefit from growth in consumer spending and should benefit from trade with stronger US, European and emerging markets economies.

In addition a falling oil price is disinflationary (a lower oil price doesn’t simply mean lower petrol pump prices, it will affect the price of many other goods and services) and as a result, it may also help persuade the European and Japanese central banks to implement further monetary easing to prevent the risk of deflation and could push any interest rate increase in the UK further out (potentially to 2016) as inflation is likely to remain well below the Bank of England’s 2% target (it was announced today that inflation declined more than the market expected to 1% in November, from 1.3% in October).”