Can falling oil prices revitalize the global economy?

26th June 2012

As it appears this could be heralding the beginning of a recovery. In a little over three months the cost of a barrel of Brent crude has fallen from a high of $129 to just $90, reports say, so could this prove the much-needed boost to the global economy?

The last few months has seen the largest fall since the summer of 2008, when oil prices tumbled after hitting a record high of $147.50 a barrel, says the Financial Times (paywall).

Why the collapse?

At present, the theme of global growth is particularly evident in the price of crude. Along with other risky assets, this has tumbled on continued worries about the state of the Eurozone, alongside mounting concerns about slowing growth in China and the US.

The second reason for the rapid fall in the oil price is the rebuilding of global stockpiles, such as Saudi Arabia pumping crude at a 30-year peak.

What is the impact of this?

There are three main effects from this.

Shaun Richards, Mindful Money's economist blogger, says on his blog: "First a falling oil price offers a stimulus to the world economy as the positive effect on the oil importing nations exceeds the negative effect on the oil exporting nations.

"Secondly, we see a reduction in cost push or commodity driven inflation.

"And thirdly, we see a reduced transfer of income and wealth from the oil importing nations to the oil exporting ones."

He adds: "There are specifics which also come to mind. For example India's trade deficit problems were exacerbated by the high price of crude oil and a lower price is sustained will help considerably in this regard. The UK has suffered from consumer inflation which has been persistently over target even in an economic downturn and a lower oil price will help dampen this. We saw the beginnings of this impact earlier this week as CPI fell to 2.8%."

However, Michaelfoddy comments on the blog: "…there will be no recovery at oil prices above, say, $40, and there is not a hope in hell that such a price level will be reached let alone maintained for long enough to get a global recovery going."

But still, it seems the current price is a welcome boost right now.

Will the price rise again?

Wisdom of recent years says that energy will become ever more expensive as a result of the rising cost of extraction, the depletion of reserves, and accelerating demand.

But could the price have further to fall, and could it remain low?

Will Riley, co-manager of the Guinness Global Energy Fund, says: "We think the most likely scenario going forward is that we will see the average price of Brent and WTI fall back to a trading range  of $80-$100 per barrel, driven mainly by the high level of OPEC production.

"Once in the range OPEC will start to cut back and any significant price weakness below $80 (average) will be prevented by significant OPEC cuts."

However, some say we are set to see a period of sustained low prices. Citigroup oil watchers believe that this shift in the supply/demand balance will lead to a long-term sustainable oil price of between $80 and $90 a barrel"

Meanwhile, Ketan Patel, senior investment analyst at Ecclesiastical Asset Management, says: "We think oil prices will remain under pressure during the current downturn which shows little or no sign of improving in the short term.

"The oil industry has been investing heavily in both conventional and non-conventional oil and we think the long term story (greater demand and higher price) is centred on increased demand from emerging economies"

The Daily Telegraph reports: "…the supply shortages that drove the oil price higher from about 10 years ago have finally been reversed as a natural consequence of an escalation in exploration spending."

Secondly: "It is the potential for the US to become energy independent as a result of technological advances in the exploitation of shale oil and gas, vast reserves of hydrocarbons that are trapped in sedimentary rock where, until very recently, they defied economically viable extraction."

And there are rising supplies with a surge in new discoveries, such as in North America.

However, if the recent falls in the oil price are sustained we can hope for some stimulus from this in the latter part of 2012. 

Shaun Richards says: "As the fall in the oil price has as one of its causes the current economic weakness it is possible that it may turn-out to be a self-correcting mechanism."

How can you invest in oil?

Oil, often dubbed 'black gold' like many other commodities, such as gold, platinum and corn, has traditionally a low correlation with equities. This means oil and oil related investments in a portfolio can provide an element of diversification, as well as a hedge against inflation.

There are a number of ways an investor can get exposure to oil. You could do so through a stock such as Royal Dutch Shell, Premier Oil, British Petroleum, Tullow Oil.

Exchange traded funds are another option, and most UK funds will have exposure to oil, given that commodities and resources firms now make up around a third of the FTSE index of the UK's top firms.

The basic fact is that commodities, and especially oil, are difficult to avoid as part of a diversified portolio.

What do you think? Do you think oil is headed higher or lower? And does this signal recovery?


More on Mindful Money:

Britain rejoins the nuclear family

Will the falling oil price rescue us just in time or just too late?

Alternative energy: an attractive investment opportunity or doomed industry?

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