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Oil market: where is the bottom?

 Kira Iukhtenko

The dramatic decline in oil prices has become the most important topic of the year 2014. Unexpected increase in oil production and weakened global demand halved the price from $115 to $60 per barrel in 6 months. Is this trend positive or negative for the global economy? As a rule of thumb, oil shocks often help the world economy to reload. For instance, the oil price crash in the year 1986 helped the economic growth to accelerate to 4.6% in the year 1988. 2008 oil depreciation also acted as a good support for the economy. According to the Oxford economics survey, every 20% price drop pushes global growth by 0.4% over the next 2-3 years. As a result, low prices could help to offset forecasted slowdown of the global economic growth in the coming years.

Cheap energy: what does it mean for the world economy?

Impact on the global economy clearly won’t be homogeneous. Oil-consuming countries dependent on imports will benefit from cheap energy. Most notably, these are the developing countries with high inflation (India, Indonesia). China - the largest oil consumer – will also feel the positive effect from the current price turmoil. United States still remain a net oil importer ($200 billion net imports in July 2013 – July 2014) and will also stay in profit. The current price setup clearly hurts the shale oil producers. However, Goldman Sachs is convinced: it will cost less than 0.1% of GDP for the US economy. Japan and euro area also enjoy cheap resources. However, this sword cuts both ways: low prices complicate the governmental fight with disinflationary pressures. With an average price of $60 dollar per barrel inflation will fall below zero in 13 euro area countries in the year 2015.

Meanwhile, economic prospects of the oil-exporting countries remain gloomy. The countries which failed to save and invest the enormous oil incomes they had over the past decade will likely suffer – Venezuela, Iran, and Russia. Saudi Arabia’s economic policy proved to be wiser: in the high prices era the government managed to build large sovereign wealth funds which will act as a safe airbag in the new reality.

Fun fact: 10 largest oil exporting countries account for 6.5% of the global GDP, while 10 largest oil importers including Europe, USA and China, account for 65% of the global GDP. Positive effect is clearly dominating on the global balance pan.

Source: WSJ

2015 price outlook

Where is the bottom for the oil price? Given the Saudi’s clear unwillingness to lower output, we see prospects for more downside to come in the first half of the year 2015 – at least until the next OPEC meeting in summer. In the coming months we could see new dips towards $40 or even $20 dollars per barrel – this is how the economic wars are done. However, let’s try to be not too pessimistic. Recovery back above $100 per barrel seems to be unlikely, but in the first half of the year we could see prices back around $70-80 per barrel. Rich Persian Gulf countries can’t leave prices under pressure for too long – that could lead to social unrest in the region. These players will be forced to soften their positions or we’ll see new “Arab springs” in the very near future. One way or another, but the price will finally be lifted.

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