Cheap Oil Analysis – Pros and Cons

Cheap oil is caused by an oversupply of oil of 600,000 barrels a day in the world market by members of OPEC marking a drop from $100 to $65 per barrel. The analysis below is biased to a Canadian point of view.

Pros Cons
The lower price of oil could mean a greater marginal utility from being able to purchase greater gallons of oil (greater purchasing power). This could also mean higher productivity as the greater gallon of oil acquired can produce more outputs.

More spending on oil by Canadians due to the income and substitution effect. E.g. feeling more wealthy due to being able to purchase more and will shift spending habits to buy more of everything.

Boosts in Canadian economy due to lower costs of operations. This means startups and smaller companies have potential to grow depending on their industry sector.

Boosts in US economy due to countries purchasing oil from them. They would have higher national income and therefore greater potential to increase jobs and investments (monetary and capital).

Stronger Canadian exports from key factors: US economy is picking up from better oil revenues and will spend more from Canada, cheaper shipping costs.

Low cost of oil will help the EU and Japan recover economically in their production and expenditures rather than through expansionary monetary policies (printing money). It should be noted that China and other developing countries benefit from this as well. In fact IMF estimates a global growth between 0.3-0.8%.

Companies and countries that benefit from this due to higher influx of revenues or decrease in expenditures signal that they have a greater cash supply to fund and invest in future endeavors. This means higher chances of job creation, business opportunities, and monetary leverage for uncertainty.

Reducing operations in the extraction of oil due to the cost outweighing the benefits and in this case revenue for oil companies. This also means higher unemployment and cuts to investment in the oil industry due to lower profit margins. Exploration projects of new oil sands would be lagged until there are expectations of higher revenues. Could cut Canadian nominal GDP by $16 billion annually.

Lower Canadian exports of oil, which means fewer buyers who will use Canadian currency to buy the oil and consequentially a depreciated Canadian dollar value.

Households are uncertain about the oil prices and are reluctant to purchase as the oil prices continue to fall until they are certain there might be a future rise in price.

Consequences for various countries especially the ones that depend on exports of oil for national revenues. This shock means the countries affected will be forced to manage their spending, lending, and economic policies in order to maintain GDP and not fall into hyperinflation due to fast depreciation of their domestic currency. IMF highlights that they should diversify their revenue streams and not have a large economic dependence

Sanctions and drops in oil prices have caused Russia’s economy to plummet.

Once this trend is over, it is possible that oil prices will be much higher than it was previously before the price plunge. This is because oil companies could be forced out of business and will be taken over.

Higher risks on derivatives markets based on oil held by banks. This coupled with pressures on depreciating currency have induced a more risk averse investing trend.

Overall, the benefits outweigh the costs on paper, but the present value in terms of money and the consequences that may not be foreseen yet has yet to be measured. Although, the net benefit is that numerous countries and businesses would benefit from the cheap oil through increased employment, investment, trade, and financial leverage, however at the expense of oil-producing companies and countries. For greater detail, the most bottom source from the IMF talks about the shifts, its persistence, factors involved, and a lot of other graphical information useful to all that wants to know more about the global economy.

Sources:

http://www.huffingtonpost.ca/salman-sakir/falling-oil-prices_b_6292224.html

http://www.cbc.ca/news/business/cheap-oil-could-be-good-for-canada-royal-bank-says-1.2889779

http://blogs.ft.com/beyond-brics/2014/12/11/mexico-the-us-and-the-imf-worst-case-oil-price-scenarios/

http://www.reuters.com/article/2014/12/22/us-imf-oil-idUSKBN0K01DB20141222

http://blog-imfdirect.imf.org/2014/12/22/seven-questions-about-the-recent-oil-price-slump/

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Posted in Economics, Finance, International

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