Friday, 31 October 2014

The upsides and downsides of low oil prices

Low oil prices should be positive for the New Zealand economy, but a number of downsides can also be expected, say analysts.

Oil prices rose slightly in the final week of October nudging $87 per barrel on the Brent crude index (WTI $82). This follows a precipitous drop over the past month where benchmark crude reached a price not seen since November 2010.

Since June this year, Brent crude oil has lost 20% of its value with most indicators suggesting the price could continue to slip. Goldman Sachs released a forecast early this week predicting US benchmark crude prices could dip to $70 in the first quarter of 2015.

Compounding factors ranging from decreasing demand in Asian markets and a stuttering recovery in Europe, to a marked increase in supply from OPEC countries and the American shale-oil boom are all contributing to an oil price slump.

That’s good news for many of the world’s struggling economies still trying to claw back from poor economic growth. It’s also healthy for companies desperate to increase tight revenue margins strangled by high energy prices over the last six years.

But with positive effects come the inevitable negative downstream effects in many economies, including New Zealand’s.

For instance, Russia has pegged its 2014/15 budget on an assumed $US116 per barrel price. If the price remains below $90 it is estimated that Russia will lose 1.2% of its GDP over the next year.

Saudi Arabian oil producers have said they can weather the downswing even if the crude price hovers around an $80 mark. But even they will have to rethink their long term strategy as the United States is predicted to produce more oil soon than even the stalwart Middle Eastern giant.

Auckland University head of energy economics Professor Basil Sharp says New Zealand imports about 6 billion tonnes of oil each year and exports close to 1.5 billion tonnes. That’s a 4.5 billion tonne shortfall, so the lower prices should help to marginally close this gap.

“Whether that helps our greenhouse gas emissions in another matter, because even though demand for fuels in New Zealand is inelastic, we might expect some response in terms of increased consumption as a result in the fall of oil prices.

“If low oil prices do translate into lower prices at the pump, from the point of view of the economy it’s probably a positive thing,” he says.

Professor Sharp says the industries likely to benefit the most will be transport intensive like the dairy or logging industries. It all depends on whether those savings are going to be fed widely through the industry.

“If there’s concentration in the marketplace it could be quite easy for a supplier to hold on to the increased revenues as a result of the lower oil prices.  So it depends on the competitive nature of our industry.”

Hayes Gold Fund chief investment officer Craig Robins says countries importing oil and most businesses will benefit in the shorter term from lower oil prices due to lower costs, better margins and lower inflation.

“Lower oil prices imply lower costs and inflation for consumers. This is great for most consumers, businesses and governments, however the reasons behind the falling oil price may signal a global economic slowdown that could negatively impact us all,” Mr Robins says.

If there is a surplus of oil it is probably best explained by the increased US shale oil availability which is bringing the US closer to self-sufficiency in fossil fuel energy.

“Of concern to US shale oil producers will be a continuation of weak oil prices. Shale oil is expensive to produce and requires oil prices of between $US80-90 to break even.

“Lower oil prices could remove marginal shale producers from the supply chain, slowing US economic growth and lead to higher oil prices longer term.” He says.

So the low oil price isn’t entirely bursting with good news. The downsides are to be found in market incentives. For example, during the steep rise in oil price in the mid-2000s, private transport owners cut back on driving hours, but only at the margins.

Most people simply rode the high price out and kept driving. The price of oil hasn’t risen high enough for most vehicle owners to constrict their driving schedules outright.

A drop in oil prices will, says Professor Sharp, encourage drivers to perhaps act a bit more liberally in their schedule. But even that’s not completely a good thing either.

“It will mean increased carbon emissions. Whether or not you agree with the connection of greenhouse gas and climate change, that’s really another matter.

“This is all linked to public transport as well. If private transport is cheaper then it could have a negative impact on the trend towards public transport,” he says.

Another, perhaps more worrying, downside is whether low oil prices will impact the government’s programme of encouraging development in New Zealand’s exclusive economic zone.

“It could create some uncertainty in the eyes of investors and the viability of offshore oil drilling developments. That could push the plans back onto the shelf, so to speak.

“It might be that one of the large developers just doesn’t find it profitable at $80 a barrel to start drilling in New Zealand waters,” Professor Sharp says.

Neither Mr Robins nor Professor Sharp predict the oil price will rise back to recovery-crippling heights within at least the next three months unless an international conflict turns off the tap in OPEC countries.

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