27th November 2014
After remaining stubbornly high throughout the financial crisis, the price of oil has dropped by almost 30% in the past six months boosting hopes that its slide will help drive further economic growth
Over the period the cost per barrel of West Texas Intermediate (WTI) has plummeted from $102 a barrel to its current level of $72.
This is positive news from an economic perspective as the cost of oil has a direct impact on GDP growth and any fall is generally seen as good news.
Cheaper oil means lower prices at the pumps, although it does take some time to work through. Given that petrol costs are a necessity for most households, any cuts in the costs will feel like a pay rise. The effect is that households feel wealthier and it should result in a boost in household spending in other areas.
Adrian Lowcock, head of investing at AXA Wealth said: “The benefits of a low oil price do not stop at the consumer. Companies also benefit. The most obvious businesses that will benefit are those which use oil intensively such as transport, airlines, manufacturers and chemicals companies. However, the impact on lower oil prices can be seen across a wide range of businesses and will lower costs for many that depend on the transportation of their goods. Retailers and supermarkets, in particular, could benefit from lower transportation costs.”
Those which are likely to suffer from a falling oil price are primarily the oil exploration companies and should the price remain lower for longer, major oil companies and support services could also be impacted, perhaps by a cut in production and mothballing projects.
But will the oil price stay low?
At the beginning of 2014 the consensus view of the oil price was in the region of $120 a barrel. Professional investors were buying oil futures at this level as tension in the Middle East and the Ukraine rose. However, supply has not been disrupted. At the same time investors have underestimated the scale and impact that US Shale gas would have on prices. In addition, global growth has slowed more than initially expected, which reduced energy demands while a strong US dollar has also contributed to a lower oil price as it means the price of oil is more expensive to other countries.
Lowcock noted that for the oil price to rise, there would need to be a pick-up in global growth and for energy demand to rise, or for OPEC (Organization of the Petroleum Exporting Countries) to limit supply. But at present it looks like OPEC is not functioning effectively with a number of participants keen to maintain market share at the expense of price.
He added: “Trying to predict where the oil price may move next is difficult, even for the experts, but there is a clear benefit to consumers and businesses in a lower oil price. The longer it stays low the better it will be for economic growth and company profits. A low oil price should continue to feed through to better economic growth and increased consumer spending, both of which will help the profitability of companies.”