George Perry writes: The sharp decline in world oil prices during the last half of this year has become the defining economic event of 2014. It has been hailed as a timely stimulus to global demand because it adds to the purchasing power of consumers. Lower gas prices have already strengthened the U.S. expansion and supported the still-fragile recoveries in much of Europe, Japan and the emerging economies. These demand side effects are still growing, but they are only the most immediate impacts. Depending on how the tumultuous events in the oil market play out, they will have important effects through many other channels, and not all these will be so desirable.
No simple generalization explains the history of oil prices. They have responded sharply to some political and economic changes and have also remained in a fairly narrow range for extended periods. In the first postwar decades, vast new oil supplies from the Middle East kept oil prices low. Then in 1973, Saudi Arabia and other oil producing states of the region nationalized their oil industries and formed the OPEC cartel which constrained output enough to quadruple the world oil price to $12 a barrel. In the years since, the ability or willingness of OPEC to stabilize prices has been uneven. Prices soared after the takeover of Iran by the clerics in 1979, and then slid back during the 1980s in the face of new oil discoveries in the North Sea, Mexico and Alaska, and the drive to oil conservation in the advanced economies that slowed demand growth. The next big move came in the 2000s, as surging demand for oil from China and other developing nations drove the price from around $20 at the end of the 1990s to around $120 a barrel in the summer of 2008. Prices crashed during the Great Recession and then promptly started back up as recovery began and China’s growth continued.
And then the new era for oil began. The introduction in 2009 of fracking for recovering oil from shale deposits reversed a long decline in North American oil production. Production grew slowly at first, and the renewed global economic expansion brought oil prices back to near $100 a barrel by 2011. Prices then stayed in a narrow range for three years as growing shale production kept global supplies rising in step with global demand. But by mid-2014, what had seemed a sustainable balance was upset as shale production accelerated and Libyan oil output rose sharply from depressed levels. As Saudi Arabia appeared reluctant to reduce output to support the market, the price decline steepened. Are the recent prices around $60 a barrel likely to be the new normal?
In the race between global demand and supply, today’s lower prices will both raise consumption and restrain the growth of supply. Both will move up the short run equilibrium price, suggesting a price in the $60s could be sustainable. But uncertainty and turbulence rather than equilibrium may characterize the oil market for some time. As Libya’s experience shows, supplies from the Middle East, including those affected by sanctions on Iran, are hard to predict.
As the range of outcomes and responses suggests, there could be pressure for market prices to move above or below present levels. But it seems reasonable to project oil prices settle in a range in the $60s in assessing 2015 economic prospects.
While the economic stimulus from lower oil prices starts immediately, some of the effects through other channels take more time. The creation and expansion of the fracking industry has been an important source of high paying blue collar jobs in the US and has contributed meaningfully to the economic recovery. With today’s much lower prices, the industry’s future plans are being scaled back sharply which will cut into the economy’s job growth in 2015. This consolidation will also lead to a rash of bankruptcies among the small firms that have spearheaded the fracking revolution. But those are the risks of a speculative industry. In the aggregate, oil production is not a dominant part of the U.S. economy and the positive stimulus from lower gas prices for consumers will outweigh the negative effects on employment and GDP in 2015.
For countries such as Russia, where oil sales are a major source of budget revenues and foreign exchange reserves, the drop in oil prices creates a huge financial problem.
