The last sustained fall in global oil prices from 2014 to 2015 was greeted as a shot in the arm for the world economy. This week’s crash, if it lasts, could be very different.
The shock to supply — which analysts say could leave crude prices hovering around their current levels of between $30 and $40 while the price war persists — is expected to put enormous strain on the economies and public finances of oil-producing countries.
In normal times the net effect on the global economy would still be positive, as lower fuel prices boost consumer demand and investment in non-oil sectors. But this time the global coronavirus outbreak offers little hope that consumers will rush out to spend the windfall.
On Monday, the International Energy Agency said it expected global oil demand to fall this year for the first time in a decade owing to China’s economic slowdown and the disruption to travel and tourism around the world.
“With a combination of a massive supply overhang and a significant demand shock at the same time, the situation we are witnessing today seems to have no equal in oil market history,” said Fatih Birol, executive director of the International Energy Agency.
Economists at Morgan Stanley say there are three main channels through which a decline in oil prices will damage the global economy.
First, it will hit capital spending in oil-related sectors and producer countries. Second, strains in corporate bond markets — with some energy companies at risk of default — could exacerbate the recent tightening in global financial conditions. Finally, while there will be a benefit for consumers, it is unlikely to translate into higher spending in the near term.
Andreas Economou at the Oxford Institute for Energy Studies, said: “Usually, consumer countries would benefit . . . but nothing is positive at the moment for anybody.”
The main oil-producing nations will feel the worst of the pain. An oil price of between $30 and $40 is not high enough for any of their governments to finance spending plans while running a balanced budget, according to IMF estimates of fiscal break-even rates.
Although Saudi Arabia’s large foreign exchange reserves mean it can tolerate low prices for some time, Mark Lacey, head of commodities at Schroders, estimates that Riyadh’s decision to slash prices while pumping more oil could cost the country some $120bn.
Mr Birol said on Twitter that in some big producer economies “sustained low prices could make it almost impossible to fund essential areas such as education, healthcare and public sector employment”, adding that this would make diversification at once “more important and more difficult due to the lack of funds to achieve it”.
Other emerging markets could also suffer. James Lord at Morgan Stanley said oil importers “may on the face of it benefit, yet they rarely do” — because sharp oil price falls were often accompanied by global risk aversion and higher borrowing costs.
The implications for the US economy are more ambiguous.
In the past, the main effect would have been to bring down gasoline prices for consumers at the pump — a development which would be a boon for any incumbent president in an election year. But now shale oil has made the US a net energy exporter and many shale producers risk falling into bankruptcy if prices remain at their current level.
“You’re going to see companies hit, you’re going to see investment decline and local fiscal bases collapse that sustain spending on health and education in oil-producing states,” said Jason Bordoff, a professor at Columbia University.
One region that should be an unambiguous beneficiary is the eurozone, where the chief effect of a fall in the oil price is to bring down consumer prices, boosting household finances.
The European Central Bank’s rule of thumb is that every 10 euro fall in the oil price brings down eurozone inflation by 0.3 percentage points within two months. “It is good news. It is one of the shock absorbers that can help,” said Holger Schmieding, an economist at Berenberg.
But he added that while the effects on investment in the US energy industry would be immediate, any benefits to European consumers would feed through only in the longer term — making it more of a “consolation” than an immediate help to global growth.
Jennifer McKeown, at the consultancy Capital Economics, said the near 50 per cent drop in the oil price since the start of the year would knock about 1 percentage point off headline inflation across the OECD — but warned that even in 2014, the decline in oil prices had not boosted consumer spending in the eurozone or US by as much as had been initially expected.
Given coronavirus fears and related lay-offs, “it seems particularly unlikely that households will respond to lower energy costs by spending more now”, she said. If anything, the drop in the oil price “has raised the threat of a deeper downturn”.