Awash in oil — for now

For oil-dependent jurisdictions, the latest plunge in prices is yet another reminder of the benefits of diversifying their economic base.

Volatility is a hallmark of the oil market. Just five years ago, in the midst of the dramatic global economic and financial crisis, oil prices were below US$50 a barrel, after reaching a peak of US$140 the year before, then recovered to above US$100 as the global economy steadied. This year also saw a sudden drop, to below US$85 in October from a peak of US$115 in June, despite political turmoil in key energy-producing regions of the world. As a result, industry leaders, governments, traders and consumers are likely reappraising their medium-term financial and economic outlook.

We’ve been here before. In addition to the turbulence caused by the last global crisis, some of us will recall the halving of crude oil prices in the space of a few months in 1986; the current swing is less significant in comparison.

Still, slower economic growth in the key new sources of energy demand — the booming economies in Asia and parts of South America — combined with new sources of crude oil that can be exploited by technology (such as shale oil in the US) appear to be game changers for the global oil market in the medium term. Since late 2013 the US, which had been the world’s leading crude oil producer until 1974, has been exporting oil again in rising quantities.

As a result of these developments, many other countries whose economies are heavily dependent on oil exports, such as Venezuela and Nigeria, have had to scramble to find new customers in order to maintain revenues. Other producers such as Russia are finding that their threats of cutting off oil and gas supplies for political reasons are making their customers look elsewhere for supply, now that it is more plentiful.

There is probably a price floor below which several producers will find it unprofitable to continue selling in the open market — some experts say that shale oil production could contract significantly below US$65 a barrel. But no one is turning off the tap just yet.

These factors suggest that downward pressure on prices will remain until the global economy escapes the doldrums. I’m optimistic that it will in 2015, but even if this happens, prices may only partly rebound.

While lower oil prices are worrisome for oil-producing regions, they are a shot in the arm for global consumers, the manufacturing and transport industries, and service industries such as tourism, for which energy costs are an important daily expenditure. That’s the good news.

The bad news is that the losers and winners in this situation may not necessarily react to their changing fortunes at the same speed. If prices plunge further, oil producers will likely batten down the hatches, slowing investment projects or reducing output, while winners may hoard part of their windfall instead of spending it, as they wait to assess how permanent this change to their fortune really is.

If such a two-speed reaction were to take place, a further downward shock in oil prices could hurt global demand in the short run — hardly what the world economy needs at this time. By preventing a sharp cutback in oil-related investments, oil price stabilization would be a better strategy for the world economy than more steep plunges.

In the long run stable supplies (from which the global economy would benefit) would depend on the international security outlook, on the construction of pipelines and other facilities permitting suppliers and customers to diversify geographically, and on global energy and environmental policies. How these factors would play out is uncertain, so expect more volatility.

For oil-dependent jurisdictions, the latest plunge in prices is yet another reminder of the benefits of diversifying their economic base and of saving for times when revenues fall sharply below expectations. Consumers should enjoy the low prices — while they last.

About the Author

Daniel Schwanen


Daniel Schwanen is assistant vice-president, research, at the C.D. Howe Institute in Toronto.

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