Are Falling Oil Prices A Precursor To A Perfect Storm

It’s only natural, if people think about the economy at all, that people think only about their own nation’s economy. However, the era of globalization demands that we consider the world as a whole when we think about the economy. When someone sneezes in Madagascar, there will soon be a world-wide epidemic of the flu. The same analogy holds for economies.

Falling oil prices and, thereby, energy prices have been dominating the economic news of late. Oil prices have fallen over 50% in the last few months and the bottom has yet to be reached. Most people would say that, except for the oil companies and related industries, low energy prices should be a very good thing for consumers and for the world economy in general. Energy price is an important contributing factor in the price of almost every thing people buy. Therefore, the prices of everything should become more affordable and provoke the consumer to buy more and that would producers would need to produce more, which should, therefore, result in more investment and more jobs. What’s not to like? Well, it behoves us to look a little deeper to understand what is behind the precipitous fall in oil prices and at how long the depressed oil prices might last.

Supply

There is currently a glut of oil in the world markets. Estimates seem to fall between 1.5 million and 2.0 million barrels a day of over supply; all of which could be attributed to the increased production coming from the United States successes in extracting oil from deep oil shale deposits. In the past, over supply was the result of a slow down the world economic growth and the OPEC (Saudis) would reduce production to drive the price back up. This time is different. Shale oil from the US is reducing the Saudi’s share of the world market and this is one of the stated reasons that the Saudis are unwilling to reduce production this time. They prefer to let prices fall until the higher cost producers (shale producers) are forced to cut production. Because some projects just came on-line or are about to come on-line, there is likely to be a further increase in supply in the short-term. Also, even high cost producers will want to keep up their cash flow for as long as possible. Eventually, however, the higher cost producers will have no choice but to cut production.

Demand

Ironically, the increased supply of oil has come at a time when the world’s economy is slowing down or, at least, it is growing at a much slower pace. For many years, the BRICS country were a major factor in world economic growth. Things have changed. Brazil, Russia, and South Africa are in recession and China’s rate of growth has slowed dramatically. In my neck of the woods, besides the harder times being experienced by Brazil, Argentina is a basket case, and Venezuela _ well, Venezuela burned their only basket. In other parts of the world we see Nigeria, an oil exporting country, is being crushed by the low oil prices as are all other oil exporting countries. Other basket cases are Ukraine, Belarus, Japan, Greece, Portugal, Spain, Italy and France. Even Germany is on the verge of falling into recession.

Low energy prices and a strengthening dollar would seem to favor the US and that’s true, at least in the short-term. Imports will be cheaper, but the higher dollar and the week world economies will hurt US exports. Also, America’s two shinning stars for the last several years, Texas and North Dakota, will suffer from the lower oil prices. A lot of high paying jobs will be lost in those states. A stronger dollar (relatively) is a drag on the economies of developing nations, which, of course, adds to the woes of the demand side of the equation.

Central Banks, Quantitative Easing, and Zero Interest Rates

Since the financial crash of 2008, the central banks of the developed countries (led by the Federal Reserve) have used Quantitative Easing and Zero Interest Rate policies to save their financial institutions. In the process, they have been killing off their middle classes. It is the middle classes of the developed nations who have historically been the consumers on which the economies of all nations have depended for growth. The central banks of the developed nations have created a situation where they know they need to stop their current policies, but they also know that if they do stop, they could easily trigger a world-wide economic collapse. So, we are likely to see more of the same. If they are very, very careful, maybe the best we can hope for is for all of the developed world to become like Japan. In other words, a slow death spiral.

Well, that’s what I’m thinking. What are your thoughts?