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Cheap Oil: Why Is It Bad News?

By Shlomo Maital

 cheap oil

 

   All too often, economic analysis seems to many like a good news/bad news joke. No economic news is ever completely happy, is it?   Take for instance oil prices. The price of oil has fallen below $30, and with Iran about to add millions of barrels to the excess supply every day, it looks like the price of oil will remain low for some time.  

   So this is good news, right? Cheaper gasoline, more discretionary income to spend, cheaper energy prices, and indirectly, cheaper goods and services… all good news. Because, when the past oil shocks (1973/4, 1978/9) zapped oil prices way up, the result was recession. So the opposite should cause…boom?   Right?

   If so, then why have global financial markets reacted very negatively to the oil price fall. Why is the rule of thumb – a 10 % fall in oil prices boosts GDP growth by 0.1 to 0.5 points – not longer true?   Why have global stocks fallen sharply?

   Note that the cause of the current oil glut is clear – Saudi Arabia. Its Minister of Oil (acting under the aegis of King Salman, young and highly pro-active) chose to take on Saudi’s enemies, Iran and to some degree Russia, by engaging in an oil price war and bashing prices down. Saudi Arabia can do this, because it is by far the world’s low cost oil producer. It can still make money when oil is $30, unlike Russia, Iran and most other nations. And $30 oil can kill a lot of American oil production, through fracking, and reduce competition in the long run.  Saudi Arabia though is suffering too, and the Oil Minister may yet lose his job.

   Collapsing oil prices seem to be taken by the world as bad news, not good, because: * they will increase instability in an already unstable world, in countries like Venezuela and the Gulf States; * oil producers are slashing their spending and investment, especially Russia, as oil revenues collapse; * many investment projects involving energy exploration are now on hold; * emerging market corporate debt of an added $650 billion was in oil and commodity industries; that debt is now much more risky; * Higher risk aversion to energy firms has spread to other parts of the market and other industries as well. * real interest rates are at near zero and there is no room to slash them lower.

     There are some winners. E.g., India, China, South Korea. But, notes The Economist, with the world still trying to dig itself out of the 2008 financial crisis hole, “the world could yet be laid low by an oil monster on the prowl.”

The most distressing aspect of the fall in global equities, due to cheap oil, is that it signals who really matters in the world. Big Oil, big capital, tycoons, the 0.01 per cent…THEY matter and they are the ones who are hurting. The rest of us 99.99?  Well, we benefit from lower oil prices… but since we are not players in global money, we don’t really count. 

Deadly Dominoes: Who Falls Next?

By Shlomo   Maital 

dominoes  

   According to Reuters News Agency, “a prominent opponent has warned Vladimir Putin his days in power are numbered, as Russia awaits the president’s response to the dramatic decline of the rouble. Putin has been silent as the currency collapsed against the dollar.”

   It’s that old déjà vu all over again. Remember August 1998? Russia defaulted on its foreign debt, after the price of oil collapsed. Oil prices, in turn, fell, because of Thailand’s crisis in July 1997 (which saw the baht devalued from 25 per dollar to over 50), leading to the so-called “Asian Contagion”, in which other Asian currencies fell and Asia went into recession. As Asian demand for oil fell, so did the price – toppling the Russian domino. Russian, in turn, would go on to topple Brazil, Argentina…and so on….

   And it is more or less recurring. The cause of Russia’s crisis, this time, is not Asia, but rather Russia’s leader Vladimir Putin, whose adventure in Crimea and Ukraine has proved costly. The Russian people appear to believe that it is all a Western conspiracy to wound Russia.   But in fact, it is in part a Saudian Arabian move, done not infrequently by that country, in order to bash oil prices down and hurt the Return on Investment for alternative energy forms that compete with its oil.    By keeping oil prices unstable and variable, Saudi Arabia can mess up the boom in fracking, wind, solar and other energy forms.   And at the same time, no one in Saudi weeps if Iran’s economy is badly hurt, along with that of Russia – and America’s enemies in general are also damaged. This episode has happened before – a sharp fall in the price of oil helped disassemble the USSR in 1989-91.

   Meanwhile, the dominos continue to fall. Israel’s agricultural exports are badly hurt by the falling ruble. Turkey’s currency hits a record low against the dollar. Bonds of oil companies Petrobras, Pemex and Gazprom plummet and yields soar. Investors bail out of emerging markets, even those that are solid.   This is a problem – emerging market companies sold $1.7 trillion in bonds since 2009. Petrobras’ debt is especially high.

     Bottom line: No reason to rejoice over Russia’s woes, even if you dislike Putin. In the end it is always the people who suffer. Once again, we learn that adventurous leaders can ruin countries, even large nuclear ones. And it is the citizens who pay the price. Once again, we learn that we live in a global village, where dominos fall continuously and sometimes in ways we cannot predict or even imagine.

Blog entries written by Prof. Shlomo Maital

Shlomo Maital

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