There are pros and cons to low oil prices.
Generally, consumers will benefit from a fall in oil prices. A decrease in oil prices would decrease the transportation cost for people as they would be spending less on fuel. This would essentially mean an increase in the purchasing power of their income which translates into an increase in their real income.
Businesses that use oil as an input would experience a reduction in their cost of production. This would increase their profit margins, some of which they may pass on to the buyers of their goods and services. Businesses may then also ramp up their production due to higher profits and increased demand. With increased demand for goods and services and higher business activity, the economy may experience a boost leading to higher growth and employment.
The falling oil prices would affect different countries in different ways. It would have favorable effects on oil-importing countries while negatively impacting the oil exporting countries. Within countries, certain regions and industries would benefit while other regions and industries may suffer. The oil industry in countries like Canada and the US may be adversely affected in terms of curtailed production. Also, new oil exploration may be postponed, at least temporarily, as the low oil prices may make them economically infeasible.
The benchmark price for crude oil has dropped by 40 per cent since July, causing oilsands investments to fall. This fall in oil price has been due to an oversupply of oil in the world market by the Organization of Petroleum Exporting Countries (OPEC) members.
OPEC is overproducing by 600,000 barrels a day, and said it would keep output at 30 million barrels a day rather than cut back and put a floor under prices, meaning there’s not much to boost crude in the near term.
In November 2014, Alberta Premiere Jim Prentice told the Calgary Chamber of Commerce on Friday that he expects the price of a barrel of oil to be between US$65 and US$75 for the rest of the year, and that government is going to have to find a way to cope with the lost revenue and make sure the budget remains sustainable.
Alberta has chronically struggled with oil prices affecting its budgets, delivering billion-dollar windfalls and shortfalls on short notice. Prentice said Alberta can’t just wait for high prices to return. As the price of crude oil has effectively collapsed and analysts have gradually acknowledged it could be a while before prices climb back up, many red flags have been raised in recent weeks over the viability of Alberta’s oil sands, which has among the highest production costs in the world. As a result, the alarmists argue Alberta’s government will lose out on billions of dollars in potential royalty revenue and the provincial economy will stall.
The adverse effect on the oil industry may have a multiplier effect on Alberta’s economy. Other industries like retail, banking or the housing industry may suffer from dampened demand due to the slowdown in the major industry, oil. This may lead to lower GDP growth and higher unemployment in the oil-rich province. Saskatchewan may also be adversely affected due to its dependence on oil production.
The common expert opinion goes if oil prices stay this low for a long time then the billions of dollars that will need to be invested and the tens of thousands of skilled labourers who would need to be hired to grow production may no longer happen.
Low oil prices might actually improve the economics around some of the higher-cost oil sands projects. That is because one of the main drivers of cost inflation in oil sands projects over the past several years has come from the increasingly high wages employers have needed to offer to attract and retain its ever-expanding workforce. Paying those sky-high wages meant producers needed $95 oil prices to make their projects work, but as growth slows, companies no longer have to get into bidding wars with each other to attract top talent.
The fall in oil prices may lead to lower oil exports and, consequently, lower demand for the Canadian dollar. In the economically all-important oil patch, project development will slow as cheap oil makes investment hard to justify. That means lower job gains, and maybe losses ahead for the oil sector and the many industries it feeds.
Yet a depreciation of the Canadian dollar would be advantageous for Canadian growth below 2.0 per cent (read: sluggish). Canadian goods and services would become cheaper in the export destinations which may lead to higher sales in the destination countries. The higher exports would increase the revenue of the exporters that may motivate them to undergo expansion and increase employment. A province like Ontario would definitely benefit from a depreciating loonie.
Lower energy prices means inflation will remain that much lower. And that means that central banks are likely to relax even further. This will give them more room to breathe on the inflation front which means that they can remain easier for longer. That should help avoid the sort of rate increases that we saw in Europe in 2011 or any other premature actions by Central Banks that might tighten policy and hurt consumption.
The Bank of Canada said the recent decline in oil prices isn’t yet at a status where it’s a threat to the overall financial system. According to the bank’s forecasts, the decline in the price of oil is expected to knock about a third of a percentage point off of Canada’s GDP this year. For every 10 per cent drop in oil, economic growth is shaved by a tenth of a percentage point. That means more than a third of a percentage point of economic growth, or a sizable chunk, is on the way to disappearing.
The impact would be worse, but cheaper energy prices are on the whole a positive development for other aspects of the economy outside of the oil industry. Governments are among the biggest losers, since they see royalties and taxes drop. Overall, the negative economic impact of cheap oil on the Canadian economy will depend on how far oil prices fall and how long they stay low.
USA & Abroad
The fall in oil prices would affect the US economy as well. As a significant energy consumer, the US would benefit from low oil prices. Consumers would gain in terms of lower gas costs and resultant higher real income that may motivate them to increase their expenditures. Again, businesses would benefit in terms of lower cost of production and higher profits. Combined with higher demand, businesses may increase their level of production.
The low oil prices may be unfavorable for the states that are dependent on fracking, the US shale industry and related industries. Low oil prices in the US may make energy projects economically unfeasible and lead to production becoming financially unsustainable. One of the big drivers of the supply glut in recent years has been the shale boom in the USA. It’s been widely theorized that the Saudis are trying to reduce the price of oil to hurt the US shale producers. That is, because many of the US shale producers have higher costs of production then the falling prices hurt their margins and profitability. In addition to being heavily indebted, many of the shale producers can’t stomach sustained oil prices in the $60-$70 range.
The biggest domestic concern is that much of the private investment that has resulted from the US shale boom will be dampened as lower prices reduce margins for many US producers. But the alternative to this is the increasing likelihood of the Keystone Pipeline. With a new Congress coming in 2015 the Republicans have a new argument in favor of the Keystone project. Obama will have his veto pen out, but he risks looking like he’s not standing up for the best interests of US consumers and US corporations if he doesn’t allow the vote to go through.
The low oil price is predicted to benefit other oil importers like the European Union and Japan. Both the EU and Japan are trying to recover their troubled economies through expansionary monetary policies. The falling oil prices may help them in their recovery by boosting domestic demand and revamping business activity. Also, it may improve their exports as lower oil prices would mean that exporters’ cost of production would decrease, making them more competitive in the export destinations. A similar trend would be observed in China which is also an oil importer.
Overall, the falling oil prices is expected to benefit the world economy in terms of increased economic activity, higher demand, increased employment and, possibly, increased trade. This would boost the growth rate of the global economy and help it to recover to pre-recessionary levels.