Sunday, December 13, 2015
Cheap oil is a bonus, but not a bonanza
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


My regular column is available to subscribers on This is an excerpt.

The drop in oil prices to $40 a barrel, and now to a couple of dollars below that level, resonates a lot with me. Readers with very long memories may recall that when the oil price soared well above $100 a barrel, even coming close to $150, I used to say that the sustainable price was $40.

If you are patient, most forecasts will come right in the end, however eccentric they seem at the time. Oil dropped below $40 a barrel, but only briefly, in 2009, and may have further to fall in the current rout.

There are two aspects of the further drop in oil prices, and in other commodities, that I wanted to discuss this week. The first is what it means for inflation. The second is whether, given the extent of the fall, we should be disappointed about its impact on growth.

On inflation, it seemed likely until recently that the fall in oil prices would soon drop out of the inflation numbers. What I mean by this is that once you get to the point at which prices now are the same as a year ago, there is no additional downward pressure on inflation. And, once we had got to that point, it would be reasonable to expect the inflation rate to start gradually moving higher as underlying inflationary pressures re-exert themselves.

That will still happen, but it will not happen for a while. This time last year crude oil prices were close to $60 a barrel, well above current levels. The average petrol price used by the Office for National Statistics in calculation inflation was 120p a litre in December last year, falling to 109p in January. Now the RAC is talking of an imminent reduction to 103p a litre, with supermarkets already charging less than £1. For most of this year, the average price has been above 110p a litre, often significantly so.

So the fall in prices will keep inflation lower for longer, and may produce more “deflation” readings in coming months. There are many reasons why the Bank of England is not ready to follow America’s Federal Reserve in hiking interest rates, and this provides another.

Bigger than this perhaps is the question of why the fall in oil and commodity prices has not done more for growth. We should be wary of concluding that growth in Britain has definitely slowed this year. The latest figures have yet to undergo much of the revisions process that we have come to know and love. As things stand, however, growth this year is running at closer to 2.5% than last year’s 2.9%.

At a global level, the International Monetary Fund estimates 3.1% growth this year, down from 3.4% last year, and the weakest since 2009, the height of the crisis. What has happened to the oil bonus, the beneficial effects of the good deflation I wrote about this time last year?

At a global level it is not too hard to explain. There are gainers and losers from falling oil and commodity prices. The gainers – every industry in the world which benefits from cheaper fuel and raw materials – will respond by investing more but may take time to do so. The losers will respond by cutting investment sharply, and are doing so. There is an overall benefit from cheaper oil, in other words, but it is complicated by timing differences. You see that in microcosm in the stock market’s poor performance this year, spectacularly so on Friday, where falling share prices for oil and mining firms have outweighed any gains elsewhere.

To take an example, according to IMF calculations, export revenues in the Gulf Co-operation Council countries (Bahrain, Kuwait, Oman, Saudi Arabia, Qatar and the United Arab Emirates) will be $275bn (£182bn) lower this year than last and, of $40 a barrel holds, even lower in 2016. Their combined budget deficit, 12.7% of gross domestic product, is bigger than that of Britain, or for that matter Greece, at the height of the crisis. The Gulf states are close to agreeing on introducing VAT in the region to raise some much-needed non-oil tax revenues.

The global story is thus essentially a tale of two types of economy, rather than a dramatic slowdown or the harbinger of something worse. For emerging and developing economies, including a huge swathe of oil and commodity producers, the fall is mainly bad news. Russia and Brazil, two of the Brics (Brazil, Russia, India and China) are in recession. South Africa is in trouble. China has not been a net oil exporter since the 1990s but its slowdown to growth of less than 7% a year has been the big factor on the demand side of the oil equation. Overall, emerging economies will have grown by around 4% this year, down from 4.6% in 2014 and 5% in 2013.

For advanced economies, the opposite has occurred. Their growth has followed the expected pattern, picking up as the benefits of cheaper oil feed through. Advanced economies should have seen 2% growth this year, up from 1.8% last year and 1.1% in 2013.

What about Britain? In many respects the economy is following the script. Consumer spending, current rising at a 3.1% annual rate, is stronger than last year, when it rose by 2.7%. Business investment, despite North Sea cutbacks, is up by 6.6% over the past year, compared with a rise of 4.6% last year.

The problem lies elsewhere. Another disappointing set of trade figures came out last week, with the overall trade deficit rising from £3.1bn in September to £4.1bn in October, as a result of a surge in imports. Net trade subtracted significantly from growth in the third quarter and may do so again in the fourth.

For this, for once, the blame lies outside the European Union. The volume of exports of goods to the rest of the EU has increased by 12.1% over the past 12 months, nearly four times the 3.2% growth in non-EU exports. Imports from non-EU countries have jumped by 10.2%, against 6.9% from the rest of the EU.

In certain cases, such as China, the fall in UK exports has been spectacular; 36% over the past 12 months. Just as exporters were being encouraged to diversify to emerging economies, which in the long run they should, some have seen the rug pulled from under them

The big fall in oil prices has put more money into British consumers’ pockets, encouraged businesses to invest more and delayed the first hike in interest rates. But it has been disruptive, and it has not necessarily made the world a more comfortable place.