By John Richardson
AS PEOPLE have frantically repositioned themselves over the last few months, one of the counter-arguments to the New Normal is that cheaper oil is a good thing for the global economy. The rationale behind this claim is that the drop in crude will boost consumer spending through cheaper gasoline and diesel etc.
But it has never been this straightforward:
- We have to understand why oil prices have fallen. The supply side is, very belatedly, well understood, but less so the demand side. The collapse of crude is largely because China has withdrawn economic stimulus as a result of economic reforms. Without the support of the levels of growth that China enjoyed in 2008-2013, the global economy is in deep trouble.
- This returns us to the supply side of the equation. Vast overcapacity in oil, gas, petrochemicals and downstream manufacturing capacity has been built up on assumptions of growth in demand that simply won’t happen. This was encouraged by the myth of China becoming middle class virtually overnight by Western standards, and was enabled by stimulus carried out by the Fed and other Western central banks: Western central bank stimulus drove interest rates to record lows and so forced lenders to seek higher yields in very risky investments.
- Put this all together and we are very likely in a new global economic crisis. First we had the dot com bubble, then we had US sub-prime, and now an emerging markets investment bubble that has also burst. Add this to today’s demographic reality of ageing populations and you have the ingredients for much lower, rather than higher, consumer spending.
- Countries such as India and Indonesia have cashed-in on cheap oil prices by cutting back on fuel subsidies that were a major drain on their budgets. As subsidies have been cut back, the full benefit of lower oil prices has not been passed onto consumers.
- There is also the environmental agenda. In China, for instance, the government is firmly committed to energy efficiency in an effort to deal with chronic air quality problems. This has resulted in the introduction of regulations designed to prevent $30/bbl crude from boosting oil consumption.
- Countries such as India, China, Japan and South Korea are of course major oil importers, and so it was only this group of countries that stood to, in theory, benefit from weaker crude. Against this positive side of the ledger has, however, always been the oil producers. The economic distress being suffered by producing countries such as Saudi Arabia, Russia, Nigeria and Venezuela has become very evident.
It is worth discussing this fifth point separately here, in more detail, in how this is affecting the US.
The breakthrough in shale gas and oil technologies are, I still maintain, one of the few genuine bright spots for the US economy. The lifting of the export ban on crude creates an opportunity to generate lots of new jobs. The cost of fracking will also, crucially, continue to fall on technological improvements, which will enable US shale oil producers to maintain high levels of production, even with prices at below $30/bbl.
But the short term distress being inflicted on the US has become very clear. The collapse in crude has led to deep job cuts by the frackers, as they scramble to deal with their excess debt. Up until December of last year, some 70,000 US oil and gas jobs had been lost. Many more redundancies will surely follow in 2016.
What is also interesting is that very old research suggests that the US economy has never benefited that much from lower oil prices. As James Hamilton writes in this OilVoice blog post:
A number of studies have looked at the effects of oil price decreases and concluded that these have little or no net positive effect on US real GDP growth. The price of oil fell from $30/bbl in November 1985 to $12/bbl by July of 1986. US real GDP continued growing throughout, logging a 2.9% increase overall for 1986, neither significantly faster nor slower than normal.
The US economy is some 70% driven by consumption, which, according to World Bank data, is one of the highest percentages globally. If the US has never really benefited from cheaper crude, what hope for the most of the rest of the world where consumption plays smaller roles in GDP growth? Obviously, also, the US economy remains hugely important for global growth in general.
As I said, people are frantically repositioning themselves. Essentially, the argument about the benefits of cheaper crude rests on this notion: Yes, I didn’t see the collapse in oil prices coming, but no matter, everything is still fine because cheaper crude is actually a good thing.
This kind of approach doesn’t move us any further forward.