How $50 Oil Changes Almost Everything

Isaac Arnsdorf & Simon Kennedy, Economic Times 8/1/15


From geopolitics to inflation, the biggest slide in energy prices since 2008 recession is shaking up things in every conceivable sphere

The plummeting price of oil means no more trout ice cream. Coromoto, a parlour in Merida, Venezuela, famous for its 900 flavours, closed during its busiest season in November because of a milk shortage caused by the country’s 64% inflation rate, the world’s fastest.

That’s the plight of an oil-producing nation. At the same time, consuming countries like the US are taking advantage. Trucks, which burn more gasoline, outsold cars in December by the most since 2005, according to data from Ward’s Automotive Group.

The biggest collapse in energy prices since the 2008 global recession is shifting wealth and power from autocratic petro-states to industrialised consumers, which could make the world safer, according to a Berenberg Bank report.Surging US shale supply , weakening Asian and European demand and a stronger dollar are pushing oil past threshold after threshold to a five-and-half-year low, with a dip below $40 a barrel “not out of the question“, said Rob Haworth, a Seattle based senior investment strategist at US Bank Wealth Management, which oversees about $120 billion.

“Oil prices are the big story for 2015,“ said Kenneth Rogoff, a Harvard University economics professor. “They are a once-in-a-generation shock and will have huge reverberations.“

Weak Prices

Brent crude, the international benchmark, fell as low as $49.66 a barrel on Wednesday , dropping below $50 for first time since 2009. Prices dropped 48% in 2014 after three years of the highest average prices in history . West Texas Intermediate, the US benchmark, plunged to as low as $46.83 on Wednesday , about a 56% decline from its June high.

“We see prices remaining weak for the whole of the first half “ of 2015, said Gareth Lewis-Davies, an analyst at BNP Paribas in London.

If the price falls past $39 a barrel, we could see it go as low as $30 a barrel, said Walter Zimmerman, chief technical strategist for UnitedICAP in Jersey City, New Jersey, who projected the 2014 drop.

“Where prices bottom will be based on an emotional decision,“ Zimmerman said. “It won’t be based on the supply-demand fundamentals, so it’s guaranteed to be overdone to the downside.“

The biggest winner would be the Philippines, whose economic growth would accelerate to 7.6% on average over the next two years if oil fell to $40, while Russia would contract 2.5% over the same period, according to an Oxford Economics Ltd’s December analysis of 45 national economies.

Inflation Outlook

Among advanced economies, Hong Kong is the biggest winner, while Saudi Arabia, Russia and the United Arab Emirates fare the worst, according to Oxford Economics.

One concern of central bankers is the effect of falling oil prices on inflation. If crude remains below $60 per barrel this quarter, global inflation will reach levels not seen since the worldwide recession ended in 2009, according to JP Morgan Securities LLC economists led by Bruce Kasman in New York.

Kasman and his team are already predicting global inflation to reach 1.5% in the first half of this year, while sustained weakness in oil suggest a decline to 1%, they said.

Negative Inflation

The euro area would probably witness negative inflation, while rates in the US, the UK and Japan also would weaken to about 0.5%. For what it calls price stability, Fed’s inflation target is 2%. Emerging-market inflation would also fade although lower currencies and policies aimed at slowing the effects on retail prices may limit the fall.

As for growth, a long-lasting price of $60 would add 0.5 percentage point to global gross domestic product, they estimate.

Even as cheaper fuel stimulates the global economy, it could aggravate political tension by squeezing government revenue and social benefits, Citigroup Inc analysts said in a January 5 report.

Either way , previously unthinkable events now look more likely .Byron Wien, a Blackstone Group vice-chairman, predicting that Russian President Vladimir Putin will resign in 2015 and Iran will agree to stop its nuclear programme.

Iran Losses

Iran is already missing tens of billions of dollars in oil revenue due to Western sanctions and years of economic mismanagement under former President Mahmoud Ahmadinejad.

President Hassan Rouhani, elected on a pledge of prosperity to be achieved by ending Iran’s global isolation, is facing a falling stock market and weakening currency .Iranian officials are warning of spending and investment cuts in next year’s budget, which will be based on $72-a-barrel crude. Even that forecast is proving too optimistic. “Iran will stumble along with less growth and development,“ said Djavad Salehi-Isfahani, a professor of economics at Virginia Tech in Blacksburg, Virginia, who specialises in Iran’s economy . “The oil price fall is not reason enough for Iran to compromise.“

The Russian economy may shrink 4.7% this year if oil averages $60 a barrel under a “stress scenario,“ the central bank said in December. The plunge in crude prices prompted a selloff in the ruble with the Russian currency falling to a record low against the dollar last month and tumbling 46% last year, its worst performance since 1998, when Russia defaulted on local debt.

Russian Production

“The risk is that, as a badly-wounded and cornered bear, Russia may turn more aggressive in its increasing desperation, threatening global peace and the European economic outlook,“ said Holger Schmieding, Berenberg Bank’s London-based chief economist.However, “the massive blow to Russia’s economic capabilities should -over time -make it less likely that Russia will wage another war.“

Russian oil production rose to a post-Soviet record last month, showing how pumping of the nation’s biggest source of revenue has so far been unaffected by US and European sanctions or a price collapse. The nation increased output to 10.667 million barrels a day, according to preliminary data from the Energy Ministry on January 2.That compares with global consumption of 93.3 million barrels a day , based on the International Energy Agency’s estimate for 2015.

Venezuela, which relies on oil for 95% of its export revenue, risks insolvency, Jefferies LLC said in a January 6 note. The cost of insuring the country’s five year debt has tripled since July, Citigroup said. President Nicolas Maduro is visiting China to discuss financing and expects to travel to other OPEC nations to work out a pricing strategy.

Confounding Investors

The US, still a net oil importer, would accelerate economic growth to 3.8% in the next two years with oil at $40 a barrel, compared with 3% at $84, the Oxford Economics study found. The boost to consumers could be offset by oil companies’ scaling back investments, according to Kate Moore, chief investment strategist at JPMorgan Private Bank. Producers are cutting spending by 20% to 40%, according to Fadel Gheit, an analyst at Oppenheimer & Co.

The mixed picture is confounding investors. The Standard & Poor’s 500 Index of US equities fell 1.9% on January 5, the biggest decline since October, as oil brought down energy shares and stoked concerns that global growth is slowing.

While cheaper oil helps consumers, business spending has a bigger effect on equities, and oil companies are set to cut investments. Oil at $50 a barrel could trim $6 a share off earnings in the S&P 500 Index this year, according to Savita Subramanian and Dan Suzuki, New York-based strategists at Bank of America Corp.

Bets on high energy prices have mashed share prices of companies such as Ford Motor Co, Tesla Motors Inc and Boeing Co. ­ Bloomberg.



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