Cheaper oil: more of a curate’s egg than a total blessing

Falling oil prices are great for consumers, and industry. They're bad for Putin and Saudi. But they're also bad for Britain's oil industry, and could potentially be highly destabilising in Africa and the MidEast. It's more complex than it appears

If oil heads further south, what next?
Robin Mitchinson
On 21 December 2014 12:12

Cheaper petrol -- what’s not to like? It will put more money in our pockets, reduce transport costs, make business and industry more competitive, and give the economy a further boost.

Brent crude is now down to around $60 a barrel with West Texas hovering at $53. Some pundits reckon on a fall to $40 before recovering to $80-ish next year.

The conspiracy theorists reckon this is a ploy hatched between the US and Saudi Arabia to persuade Putin to drop his support for Assad. Others say the Saudis are trying to undermine the American fracking industry, which has enabled the US to cut its imports by over 8 million barrels per day, equivalent to the entire output of Nigeria and Saudi combined.

It will become a net exporter within the next four years and be independent of Gulf oil. So the Saudi strategy just won’t work. Most of the shale output has been hedged for 2015, in addition to which  some producers can survive with prices as low as $50 per barrel and in some cases much lower. Costs will continue to fall as start-up costs are amortised.

It will weaken Putin’s grip as the energy-dependent economy of Russia begins to seize-up; prices are now well below production costs and it might be impossible to balance the budget or to fund his lavish rearmament programme. He may -- just may -- rethink his policy on Ukraine (although it is just as likely that he will lash out in some way if he is cornered).

It will undermine Iran’s Middle East meddling. It will encourage the current bull market in equities.

Only it’s not all good news

It’s not just oil. Other commodity prices are going south rapidly -- iron ore, gold, copper, platinum, sugar, cotton, soybean and most others. This is not such good news.

It is a pretty good indication that the world economy is slowing down; the falls are in real money, not just relative to other price levels. Demand has fallen for energy, minerals and food products as economies have contracted. GDP forecasts have been revised downwards in most countries, including  the big player, China. This is particularly bad news for China’s main commodity suppliers, such as Australia.

There are other reasons. QE has pushed-up commodity prices. The Fed is on the brink of ending QE and tightening monetary policy. This signals an increase in the $ interest rate, in which world commodities are priced. High interest rates are an incentive to pump or drill now because it is not good practice to hold large inventories.

Rising interest rates encourage portfolios to shift into other asset classes. This is good news for people who depend on bank deposits for a slice of their income and who have been badly hit over the last few years. It is not so good for people with heavy mortgages.

And we must not overlook Britain’s own oil industry. Tax revenues will fall even further. As many as 15,000 jobs may be lost. Further investment in North Sea oil will dry up.

On the broader front, it may cause further instability in countries already beset with Islamist threats – Nigeria, Libya, Egypt, Algeria and the Sahel. Cash-strapped Oil Sheiks might no longer be able to buy-off the Islamists. In addition, Venezuela is imploding and Brazil, heavily dependent on energy exports, is groaning under a mountain of debt accumulated during the good times.

The oil producing countries are bleeding money. To break-even, Russia needs  $105 pb, Venezuela $161, Nigeria $126, and even Saudi requires $98.

All this may threaten already fragile world security, when even Saudi is under threat. Northern Nigeria is highly likely to become a Boko Haram stronghold, spreading terrorism further across West Arica. Saudi is betting that that this regional economic shock can be contained for another two years. It would be unwise to take the bet.

So the plunge in oil prices is more of a curate’s egg than a total blessing.

Robin Mitchinson is a Contributing Editor to The Commentator. A former barrister, living in the Isle of Man, he is an international public management specialist with almost two decades of experience in institutional development, decentralisation and democratisation processes. He has advised governments and major international institutions across the world

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