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February 2015

Will Oil Prices Continue To Fall?

Published: Friday 13 February 2015


The falling oil price has affected countries, economies and consumers the world over. David Johnson, Director at Halo Financial, ponders what may happen in the months ahead.

In the six months from July 2014 to January 2015 the price of crude oil (West Texas Intermediate to be precise) fell from $100 (£66) per barrel to just $45 (£30). While there was no single reason for this slump such a dramatic change was no accident; Opec, the 14-member oil producers' organisation, had all manner of opportunity to reduce production, but it very pointedly declined. Whether such motivation was linked to putting pressure on Russia or whether Saudi Arabia is trying to make it unprofitable for other producers to compete is open to unending speculation, but the halving of the crude oil price has repercussions for all. Undoubtedly, Opec members are keen to compete with growing shale production in the US and Canada's oil sands production. Both techniques are more expensive than traditional drilling and extraction methods and, while estimates vary, most analysis suggests neither technique is profitable below $60 (£40) a barrel. The impact on raw material costs in the plastics industry and road transport costs is well known, but the impact on national economies can be largely split into two obvious ends of the spectrum: users and producers. For energy exporting nations you need only look at their currencies to see the economic impact of the oil price fall. For example, in this same six months, the Norwegian krone has shed 16% of its value, whiel the Australian dollar is off by 13%. The weakness in the Australian economy - brought about by falls in not just energy prices but across its commodity exports - may well prompt interest rate cuts by the Reserve Bank of Australia. For the large scale importers, including the UK, the benefits are obvious. Barclays Bank calculates that if crude prices stay around the $50 (£33) level for the whole of 2015 it will shift $1.6trn (£1trn) from oil producers to oil consuming nations. Lower oil and energy prices shave points off the cost of living; this is already being seen in lower consumer price inflation across the globe and is evident in lower producer price costs as well. Ultimately, lower costs for industry feed into lower factory gate prices and that also dampens consumer inflation, eventually. In Europe, deflation is a real challenge for the European Central Bank (ECB), struggling as it is to restore growth to the ailing currency sharing bloc. Although late to the party, the ECB has embarked upon a process of pumping €1.1trn (£730bn) into the Eurozone economies to try to stimulate growth and hopefuly create some inflation to counter deflationary pressures. The question on everyone's lips is 'How long will oil prices stay depressed?' As with most complex and yet simple economic questions there is no straightforward answer. It is unclear whether the decline in western demand for oil is behind this fall, of whether the increase in US shale gas supplies is having an effect. If these factors are significant the oil price has no chance of rallying unless supply is reduced - and we have seen the Saudi reaction to that in the past six months. Further oil finds may well dampen the price even further, but it is hard to see the motivation to find new oil fields if the price doesn't produce a return on the investment in development and extraction on existing fields. Oil prices can spike on geopolitical tensions, but we are not seeing that kind of reaction to the Russia/Ukraine crisis nor the terrorist threat in Syria. In fact, the advance of Isis almost corresponds with the slump in oil prices. The conspiracy theorists might think Opec is trying to starve Isis of income, but that is a thought for another time. In short, there is little to suggest oil prices are due to rally in the near future. However, energy prices react very rapidly if global markets are hit by shock waves, so don't for a second think that, given the right stimulus, this particular issue couldn't unravel in an instant.

Printed in PRW Magazine | 13 February 2015 | Read more online at www.prw.com