Global Oil prices hit record lows

December 3, 2018

Global oil prices have crashed 30% over the past 7 weeks due to excessive production in leading oil exporting countries. Brent and Crude oil prices are now at their lowest point since October 2017. Oil continues to be an essential commodity in the modern globalized world, and does affect both macro and microeconomic activity. With any change to oil price, economies can benefit or suffer from the effect the same has on inflation, on trade balance and on GDP. Policy makers have not intervened yet, most likely because they are holding back ahead of the crucial G-20 meeting that is held this year in Buenos Aires.

 

 

Background

As previously mentioned, the crash in oil prices stems primarily from a severe oversupply in its production, with the main culprits coming from Saudi Arabia and the US. In Saudi Arabia, oil production has risen from 11.1 million to 11.3 million barrels per day over the course of November. Over in the US, fracking and energy extraction from shale rocks has reached record highs. The US now occupies approximately 50% of the global market, whilst experiencing a larger net increase in the production of oil than the entire of OPEC over the last few years. Unsurprisingly, as firms continue to flood the market, prices continue to plummet.

 

Winners and Losers 

For some economies, such as Japan, who are struggling below the target 2% inflation, the fall in oil prices puts more pressure on the central banks to provide monetary stimulus to mitigate downward pressures on inflation levels. This may prove particularly difficult as rates are currently at 0%, meaning that QE will be essential for this stimulus package. For oil exporters, we expect a fall in GDP, as lower prices will decrease company profits and export revenues. Analysts predict a slowdown of 1.5% to 2% of GDP in countries such as Nigeria, UAE and Russia, with even worse economic effects for Saudi Arabia, where export sales from petroleum account for 42% of GDP. 

 

On the other side, we may observe countries benefiting from the recent news, particularly oil importers who are running large current account deficits. South Africa, for example, whose deficit amounts to 2.4% of GDP, will be able to import oil at a cheaper value, and narrow their deficit. Furthermore, the deflationary effects may benefit those economies that are battling against upward inflation pressures. Lower oil prices will mean less pressure on central banks to raise interest rates as a method of controlling the price level. In Brazil and India, for example, the central banks have been reluctant to influence inflation levels through contractionary monetary policy, as this would have negative effects on output and GDP.

 

Policy Response and Future Implications

The fall in oil prices comes at a very difficult time for economies, especially for central banks such as the Bank of England, Federal Reserve and ECB, which have intended to start increasing interest rates and slowly withdraw QE. Unfortunately these projects might have to be delayed or performed at a slower pace in order to prevent further deflationary risks. In the US, commentators assume that monetary policy will tighten, perhaps in the form of fewer rate hikes (3 rate hikes as opposed to 4 over the course of 2019) or less withdrawal of QE. Furthermore, oil businesses have now been advised to cut back on production in order to prevent a further decrease in price. Firms continue to worry that they will not be able to survive under constantly decreasing prices due to the strain it has on company profits.

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