Global implications of the oil price crash

The steep decline in oil prices has been one of the most significant global economic developments over the past year. On Tuesday, the Carnegie Endowment held an event on “Oil Price Trends and Global Implications” to address the consequences. The panelists included Aasim M. Husain, Deputy Director in the Middle East and Central Asia Department of the IMF and Chair of the IMF Interdepartmental Oil Group, Uri Dadush, Senior Associate at the Carnegie Endowment and Mark Finley, General Manager for Global Energy Markets and US Economics at BP. The event was moderated by Michele Dunne, Senior Associate in Carnegie’s Middle East Program.

Husain assessed that the drop in oil prices will persist in the medium-term. Initially, when oil prices fell, futures prices did not fall with spot prices. Instead, spot prices fell around mid-year while futures prices started to fall in October. Markets expect some recovery of spot prices, but because of decline in long-term oil prices, the recovery will not be full—oil prices will not go back to $90-$100 per barrel, but they can go back to $70-$75 per barrel. Futures prices are predicted to remain in the $40-$100 range.

The drop in price was a result of decrease in demand as well as increase in supply. Unlike in 1986, when Saudi Arabia’s sudden increase in supply crashed oil prices, in 2014 the world experienced the shale gas revolution, lower extraction costs for oil and lower demand. Basically, a combination of factors led to the oil price crash, although supply factors played a larger role.

Unsurprisingly, “pass-through”—the change in oil price passed on to consumers—was minimal worldwide. Since many countries regulate or fix petroleum prices, consumers did not get the entire benefit of the oil price decline. The biggest pass-throughs were in Europe at 80% and in North America at 50%. Husain claimed that if oil prices were fully passed through, global growth would increase by 1% in a year.

The beneficiaries of the low oil prices have been governments and state-owned enterprises. What they do with revenue determines the consequences of the oil price shock. Some may increase government spending, while others may save more. The losers have been oil-producing countries that are receiving lower oil revenues and therefore have less to invest in global financial markets. Fortunately, many of these countries have accumulated large buffers that will give them time to make adjustments to the price decline.

Finley attributes lower oil prices mainly to changes in supply. In 2014, global consumption was in line with the long-term historical average, but supply was exceptionally strong—global oil production grew at almost twice the historical rate. All the net growth came from outside the OPEC countries, with the US shale gas revolution leading the way. In 2014, the US surpassed Saudi Arabia and Russia to become the world’s largest oil producer since 1985. Both Canada and Brazil also saw record increases in oil production and achieved all-time record levels on average in 2014. Global demand and non-OPEC production have begun to respond to lower oil prices, but the substantial increase in oil production means that the market remains significantly oversupplied.

Like Husain, Finley believes the persistent decrease in oil prices will continue through the medium-term. However, one must keep in mind ongoing supply disruptions in the Middle East and North Africa. Finley warned that any policy must be robust across a range of prices or be able to adapt to significant and unexpected price changes in the future.

Dadush believes oil price shocks stimulate economic activity in the short-run by redistributing income towards people who consume more with a high propensity to consume. But this effect lasts only so long. There will be—and already are—significant cutbacks in energy investment. Oil is only 2% of the world GDP when one looks at production, so an oil price change even by 50% doesn’t have a huge stimulatory effect on world supply. This means the stimulus from the oil shock is short-lived even if there is high pass-through.

With regard to the Iranian nuclear deal, the panelists agreed that the return of Iranian oil will increase supply, but it is unclear by how much because of uncertainty about Iran’s capabilities and the response of other OPEC producers. Any volume of incremental Iranian production would simply add to an already oversupplied market.