What is the economic impact of a higher crude oil price?

One piece of economic news dominated all other yesterday and it was at least a change for the Trump and Brexit circuses to take something of a break. Instead we had the OPEC circus which finally came up with something. Of course we know that announcements are one thing and implementation another but there was an immediate impact on the crude oil price. From Reuters.

The price for Brent crude futures (LCOc1), the international benchmark for oil prices, jumped as much as 13 percent from below $50 on Wednesday and was at $52.10 per barrel at 0806 GMT, although traders pointed out that part of the jump was down to contract roll-over from January to February for Brent’s front-month futures.

U.S. West Texas Intermediate (WTI) crude futures rose back above $50 briefly before easing to $49.63 a barrel at 0806 GMT, though still up 20 cents from its last settlement.

Volumes were very high too which makes a past futures traders heart lighter although of course we need to note that this is a result of yet more central planning.

The second front-month Brent crude futures contract, currently March 2017, traded a record 783,000 lots of 1,000 barrels each on Wednesday, worth around $39 billion and easily beating a previous record of just over 600,000 reached in September. That’s more than eight times actual daily global crude oil consumption.

Also as we note the influence at times of banks on commodity markets ( I believed their trading desks helped drive the last commodity price boom) maybe such high volumes are a warning signal too. But if this lasts we have the potential for a type of oil price shock as we have become used to relatively low oil prices. Also central banks may have to make yet another U-Turn as of course they may find that they push inflation above target as a higher oil price adds to all their interest-rate cuts and QE style bond buying.

Let us have a little light relief before we come to the analysis and look at this from February of this year. From Bloomberg.

Oil could drop below $20 a barrel as the search for a level that brings supply and demand back into balance makes prices even more volatile, Goldman Sachs Group Inc. predicted.

Oh well…

A higher oil price is good for us?

I made a note of this when I first saw it as it is the opposite of my view. I also note that it is Goldman Sachs again. From Bloomberg.

Higher oil prices would be a boon for the global economy, according to Goldman Sachs Group Inc.

Really! How so?

Pricey crude means economies such as Saudi Arabia take in more money than they can spend, which financial markets help distribute through the rest of the world, boosting asset values and consumer confidence, the bank’s analysts Jeff Currie and Mikhail Sprogis wrote in a Nov. 22 research note.

Apparently we can ignore the elephant in the room.

Forget the stagflation of the 1970s.

Here is the explanation.

“The difference between today and the 1970s is that oil creates global liquidity through a far more sophisticated financial system,” Currie and Sprogis wrote. “More sophisticated financial markets in the 2000s were able to transform this excess savings into greater global liquidity that increased asset values, lowered interest rates, and improved credit conditions that spanned the globe.”

Convinced? Me neither and it is hard to know where to start. One view is that the world economic expansion drove the oil price higher. Another is that greater global liquidity is an illusion as we see so many markets these days which seem to lack it. For example we are seeing more “flash crashes” like the one which happened to the UK Pound overnight a few weeks or so ago. This is of course in spite of the fact that central banks have been doing their best to create global liquidity and indeed cutting interest-rates.. Still if it created “increased asset values” the 0.01% who no doubt represent Goldman Sachs best clients will be pleased. As a final rebuttal this ignores the impact of lower oil prices on inflation and the key economic metric which is real wage growth.

Did the credit crunch never happen?

From 2001 to 2014, excess savings outside the U.S. grew to $7 trillion from $1 trillion as oil climbed, according to Currie and Sprogis. The savings helped drive up values of things like homes and financial assets and loosened credit markets for consumers.

I guess this is the economics version of all those strings of alternative universes in physics where Goldman Sachs is in another one to the rest of us, or simply taking us for well, Muppets.

They are not the only ones as the IMF got itself into quite a mess on this front back in February.

Persistently low oil prices complicate the conduct of monetary policy, risking further inroads by unanchored inflation expectations. What is more, the current episode of historically low oil prices could ignite a variety of dislocations including corporate and sovereign defaults, dislocations that can feed back into already jittery financial markets.

Are these “jittery financial markets” the same ones that Goldmans think are full of liquidity? Also you may note the obsession with central banks and monetary policy and yes asset values are in there as well.

Returning to Reality

There is an income and indeed wealth exchange between energy importers and exporters. For example Oxford Economics did some work which suggested that a US $30 fall in the oil price would boost GDP in Hong Kong by 1.5% but cut it in Norway by 1.3%. So we get an idea albeit with issues in the detail as I doubt the UK (0.8%) would get double the GDP benefit of Japan (0.4%) which of course is the largest energy importer in relative terms of the major economies. Oh and there are bigger negative effects with Russia at -5% of GDP and Saudi Arabia at -4%.

However the conclusion was this.

Lower oil prices should give a sizeable boost to world GDP in 2015 and 2016

There was a time (July 2015) when the IMF thought this as well.

Although oil price gains and losses across producers and consumers sum to zero, the net effect on global activity is positive. The reasons are twofold: simply put, the increase in spending by oil importers is likely to exceed the decline in spending by exporters, and lower production costs will stimulate supply in other sectors for which oil is an input…… the fall in oil prices should boost global growth by about ½ percentage point in 2015–16,

It would also produce a fall in inflation which will be welcome to those who are not central bankers.

Comment

Should the oil price remain higher it will reduce global economic growth and raise inflation. If we compare it with a year ago it is around 10 US Dollars higher but we also need to note that in December 2015 the oil price fell to the Mid US $30s so we need to do the same to prevent an inflationary effect. As I have been writing for some months now unless we see large oil price falls inflation is on it way back. We are of course nowhere near the US $108 that a Star Trek style tractor beam seemed to hold us at a while back. But as I note the rise in some metals prices ( Zinc and Lead in particular) commodity price rises are back in vogue. So there will be plenty of work for those economists who want higher inflation explaining how they are right be being wrong.

There will also be relative shifts as consumers will be poorer as real wages fall but say shops in Knightsbridge and the like seem set to see more Arab customers. Japan will be especially unhappy at a higher oil price. But US shale oil wildcatters might be the happiest of all right now and may even boost US manufacturing as well. In the UK there will be a likely boost for the Aberdeen area.

Me on TipTV Finance

“Outlook for RBS is dreadful”, says Shaun Richards – Not A Yes Man Economics

 

 

 

 

 

 

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17 thoughts on “What is the economic impact of a higher crude oil price?

  1. Shaun,

    KSA still has budget problems so needs a higher oil price hence OPEC action but will Russia just take the money and not cut production?
    Although UK fuel duty frozen VAT still applies so any price increase compounded and oil price rise has knock on effect for other energy prices.
    Await to see if demand deficit in UK with resistance to price increases with falling demand/switching as disposable incomes squeezed?

    • the daft thing here in general is that HMG has committed to carbon reductions that mean if we increase flights , a la Heathrow and Gatwick, then virtually everything else has to be zero emissions…

      and if cars all go EV then HMG looses the tax revenues
      ( trucks at this time are a sticking point with Electric motors – just not powerful enough).

      thats estimated by the RAC to be £13 Billion short by 2029…..

      all of it if we go full EV of course

      Forbin

      • I’m skeptical about the electric motors ‘not powerful enough’, what about electric train motors ? More like the batteries aren’t up to the job

      • I very much favour EVs, and not because they reduce carbon emissions; I’m very much an AGW-sceptic, and the power still has to be generated.
        The point is that the power they use can be generated remotely, reducing urban pollution, a very positive environmental move.

  2. hello Shaun

    As mentioned in older posts the effect of dropping oil prices is falling out of the CPI/RPI and we’re left with institutionalized inflation , and steady services inflation

    Oil I’d posit , has not been “cheap” for a while and is lurking back to its pre-2008 price .

    the average price I predict ( yeah I know!) for next year will be approx $65 +/- $5

    events will make some peaks of course

    This will add to any inflation that’s caused by a weak pound. and the Brexit fiasco is still running its course

    And the debt mountain ? Well if all goes pete tong , we can just print more money ! ( until we can’t)

    Forbin

    • Hi Forbin

      Yes we are going upwards in the oil price at the moment when the latter part of 2015 was on the down escalator. I expect the shale oil boys & girls to increase production as they are essentially a debt servicing game as we have discussed before and non-fixed rate debt has got more expensive. Some of them may now be in a zone where they can make a profit.

      Still with the UK Pound £ making US $1.26 today at least that is not adding to our inflationary woes.

  3. Its always about boosting asset values isn’t it? As if that helps the majority of people and not the few asset rich? Ok, we may benefit via our pension funds but the average person see’s very limited improvement assets rise.

    On a different subject (i.e using Brexit as an excuse for price increases); I inquired about having my watch serviced today and the price of the service had gone up exactly 25% since when I last asked about this in July, ‘due to increased costs following Brexit and the need to import spares from Europe’ I pointed out that labour costs are the vast portion of service costs and in any event the pound is only 10.5% down against the Euro and not 25% but was told that they had had to incur ‘significant costs’ because of Brexit! How I didn’t explode on the spot still surprises me but I managed to walk out with gritted teeth. An independent company will get the work.

    • typical case of Rip Off Britain

      pound improved today – but no one is going to announce drops in prices because of it …..

      Forbin

  4. Hi Shaun
    Anyone who seriously believes Saudis and Iran will stick with any ‘agreement’ is a few slices short of a loaf. Rig count in US has been going up as the price increased. The SRMC of shale is probably near $50 now. So unlikely to see sustained price above this level.
    I suspect all of this is shortly to be subsumed by the effect of Trump’s end to the ‘war on coal’ and $1trillion infrastructure spend.

    • technically KSA is stuck with large water floods and advanced gas injection for their main old fields , if they cut they risk damage and lower production later.

      they will not cut from those fields if they can help it, period.

      Iran needs money just like KSA , they’d like to produce more but it not certain the state of their fields because of sanctions.

      Shale is in the poo for sure , unless the companies go bust and others pick up on cents on the dollar.- estimate break even hasn’t shifted much from $65.00 bo.

      decline rates are alarming – keep re-fracking or dwindle away.
      depletion never sleeps, like rust.

      note: there’s been little real technical advances what ever you hear , $100 + prices drove the “boom”

      once drilled re-fracking keeps them alive , but you still have to keep re-fracking ……. the cost dropped but its still a bit more than normal fields to keep the flow going

      cutting everything to the bone has helped since , expect more oil though if we can hold steady at $150 or more – this is not cheap to drill and extract oil like KSA .

      Also expect a major jump in “oil” reserves once the USA government decide to call Kerogen “oil” – its a pre-cursor that hasnt been cooked enough to be real crude oil – but we now call tar sands oil , so what the heck

      Forbin

      • Hi Forbin
        I said SRMC not LRMC ( including financing costs). Whats there is there , whoever owns it , whatever bankrupcy has occured. Re-fracking is getting cheaper all the time, there have been real developments here.

    • Update on French interconnector and electricity supply and prices. On Sunday half the capacity went until end of February at earliest, its assumed because of an anchor in the storm. Means max imports are probably down to 1GW at peak.
      Get the propane heaters and candles ready!

      • Hi JW

        As my flat is of an old design and build I have a chimney so I will have to check if the fire lighters I bought some years back still work! Then I could at least have a fire in the grate. Might be a bit smoky though as it is a while since I have had the chimney swept.

    • Hello, JW. On November 30, Canadian PM Trudeau approved two oil pipelines, one to Vancouver and another to the US MidWest, both expansions of existing lines. This already seems likely to encourage new oilsands projects that might not otherwise have gone ahead because of concern about tranport constraints. As you say, in spite of the planned OPEC cut, there is a lot of new supply that could come onstream outside of OPEC to limit price increases..

  5. Great blog as always, Shaun.
    Canada would be one of the countries that would benefit from the higher oil prices. A study from Brandon Schaufele at the University of Western Ontario earlier this year calculated that a $40 drop in the price of a barrel of oil would imply a 0.6% decline in GDP.
    http://www.ivey.uwo.ca/cmsmedia/2115841/the-impact-of-oil-price-shocks-on-canadian-national-and-provincial-gdp.pdf
    Your blog dealt with the Brent crude price, but the Ivey Business School estimate relates to the West Texas Intermediate price. It went up by 9.3% yesterday, ending the day at US$49.44. So an increase of about $5 in the oil price as just happened would imply an increase in GDP of about 0.08%. It’s not a lot, but this is because the much more substantial positive impacts on the oil-producing provinces of Alberta, Saskatchewan and Newfoundland and Labrador.

    • Hi Andrew and thanks

      So we see a small boost for a net gainer which is Canada and if other raw materials prices rise then there will be other gains. I took a look at the Globe and Mail to see what was going on elsewhere in the commodities complex to find instead a consequence of higher bond yields.

      “Toronto-Dominion is raising mortgage rates again — and this time the lender is going much farther than its recent hikes.

      Starting December 1, all fixed rate mortgages that take more than 25 years to pay back will cost borrowers an extra 10 basis points, or 0.1 per cent. TD is also implementing an extra cost for mortgages on rental properties, charging borrowers 25 basis points more.

      The changes follow Royal Bank of Canada’s precedent-setting decision early in November to hike rates, and to also charge more for lengthy mortgages. The latter move marked the first time such a policy was implemented in Canada.

      In response, TD increased its own fixed-mortgage rates a week later, but took a more measured approach. Royal Bank hiked its fixed five-year mortgage rate by 30 basis points, to 2.94 per cent; TD raised its equivalent rate by only 10 basis points to 2.69 per cent.”

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