One of the features of the economic landscape since the summer of 2014 has been the falling oil price. If we look back it feels that the price of just below US $116 per barrel for Brent Crude Oil is from another economic world and of course that is true now. But back in late June 2014 it flirted with such levels after even higher prices and of course forecasts. Goldman Sachs were (in)famous for calling for US $200 oil in 2008 and in 2011 Nomura stepped up to the plate.
If Libya and Algeria were to halt oil production together, prices could peak above US$220/bbl…… we estimate oil could fetch well above US$220/bbl, should Libya and Algeria stop production.
How much is well above please? Anyway I introduced some past forecasting perspective because this week has already seen some efforts at forward guidance on this front. From Bloomberg.
A rapid appreciation of the U.S. dollar may send Brent oil to as low as $20 a barrel, according to Morgan Stanley….“Given the continued U.S. dollar appreciation, $20-$25 oil price scenarios are possible simply due to currency,”
Oh and a familiar firm had already predicted such a number.
Goldman Sachs Group Inc. has said there’s a possibility storage tanks will reach their limit, pushing crude down to levels necessary to force an immediate halt to some production.
An easy one for the spreadsheets as all they had to do was remove a zero from the past spreadsheets as I guess we are all reminded about the “Muppet” scandal. In such a situation what is an investment bank to do? Well this is the solution from Standard Chartered via Reuters.
“We think prices could fall as low as $10/bbl before most of the money managers in the market conceded that matters had gone too far,” it added.
Should it happen then one contributor may finally be happy with the oil price 🙂
Where are we now?
The first wave of the oil price fall took us down into the mid 40s in terms of the US Dollar and it did so around this time last year. following that there was a bounce to nearly US $70 but then the move acquired a second wind. Since the middle of May 2015 the oil market has again acquired a taste for the repetitive rhythms of Status Quo.
Get down deeper and down
Down down deeper and down
Down down deeper and down
Get down deeper and down
This morning Brent Crude Oil dipped below US $31 per barrel finding itself going back in time to 2004 as it did so. There has been around a 20% fall this January alone and market volumes have been very high. Combining this with the rumours of an emergency OPEC meeting which have just arisen makes me wonder if someone is what is called “long and wrong” in size? I will return to this issue later. But for now we return to an oil price which is much lower.
The impact on inflation
If we start with producer prices then most input numbers have been blitzed by this. for example we have been reminded of this today by the UK’s poor manufacturing numbers.
Input prices paid by UK manufacturers fell by 13.1% in the year to November 2015……..Over the past year the manufacturing industry has experienced deflation, in terms of the prices manufacturers pay for materials and fuels used in the production process (input prices) and the prices they charge for the goods they produce (output prices).
As UK manufacturing has fallen over the year for once the deflation moniker has some justification. I covered the problems there back on December second of last year.
There is also the impact on consumer inflation which we can look at from today’s official data on fuel prices at the pump. The price of petrol at 101.9 pence is some 7 pence lower than a year ago and the price of diesel at 103.4 pence is some 12.8 pence lower than a year ago. So not only are we seeing a price fall there is a welcome price bias for diesel drivers like me. The direct impact on consumer inflation is show below.
A 1 pence change on average in the cost of a litre of motor fuel contributes approximately 0.03 percentage points to the 1-month change in the CPI.
As you can see in just very round numbers we are looking at a 0.3% push lower from the direct effect and of course there are many other effects. There is the direct effect on domestic energy costs -well hopefully anyway- and lots of indirect influences on fares and transport costs. But the fundamental point is that an influence which might have faded in the latter part of 2015 is pushing into the early part of 2016.
This will be an influence on central bank and indeed Bank of England policy as it continues to pull us away from the 2% per annum CPI inflation target.
There are various routes as to how a lower oil price can benefit an economy. On the 29th of January last year I explained how I expected lower inflation to boost real wages and lead to a boost in consumption in the UK ( and Ireland and Spain). That proved to be true and has been in evidence in quite a lot of places although its impact on the United States has been relatively weak.
If we look at the overall impact then Price Waterhouse estimated this last March for the UK.
in Scenario 1, where the oil price remains persistently low at US$50 per barrel between 2015 and 2020, the initial impact will raise the level of real UK GDP by around 1.2% in the first year.
We have had that of sorts and are now facing the possibility of a sustained oli price that is even lower although of course matters are volatile. But the theme here is of an economic boost which also will get a second wave if oil prices remain at current levels or fall further.
For the UK there has also been something of a (space ) oddity from the oil price fall. Take a look at this from today’s poor production numbers.
There were increases in 3 of its 4 main sectors, with the largest contribution coming from mining & quarrying, which increased by 10.5% (on last November).
Curious is it not? I will have to enquire again as I am not sure that the impact of the maintenance cycle can fully explain this ongoing rise. You see if we look back UK oil and gas production has been in secular decline.
mining & quarrying and electricity, gas, steam & air conditioning, which continued to decline following the downturn, were 29.4% and 9.1% below their respective values in Quarter 1 (Jan to Mar) 2008.
A transfer from producers to consumers
Not everybody has gained from the oil price fall as producers have been hit hard. This has appeared in the news in various guises from the falls of the Russian Ruble to the budget problems and currency issues of Saudi Arabia to problems for parts of Africa. There must be issues for Canada as well as its tar sands oil has an even lower price than the ones quoted above.
So there are implications here from a transfer of economic gains or to be more specific lower transfers from consumers to producers. In our highly stressed world we have to question if our system can take it.
The issue here is of what has become called a Black Swan event which is certainly easier to type than the serially uncorrelated error term! If we return to the concept of our stressed world then an obvious issue is the economic model of the US shale producers which looks to have been essentially a cash flow projection except much of the cash has dried up. There will be trouble ahead with anything like the current oil price and the only question is how much?
The indirect issue comes from my old line of work in derivatives. With oil at US$100+ and projections for US $200+ what could go wrong with writing some US $70 or US $60 put options? Free money isn’t it? Oh hang on…….
Big moves in our financially stressed world lead to fears that some have been caught out and the size of the move would be the prospective problem.
In ordinary times then for most nations the oil price fall would be nearly unambiguously good news. The fly in the ointment would be a reduction in demand from the oil producing nations and areas. So we continue with the associated good news of lower inflation and higher economic output as the impact of an improved real wage position is felt.
The danger is that in the race for “yield and returns” someone has been a combination of silly and desperate and done so in a large volume. Fingers crossed.