Wednesday, November 25, 2015

Economy: In Praise Of The Oil Flood

(Drivebycuriosity) - If we believe Goldman Sachs then the price of oil could soon drop to $20 because the world is floating in oil and will quickly run out of storage capacities (telegraph).  The reason: Saudi Arabia is flooding the market with oil because they want to squeeze out the US oil producers (frackers) who had initiated the global oil flood (econbrowser).  Iraq, another big OPEC supplier, is also swamping the markets because their oil production is recovering from years of war. And the American oil production is still close to record highs.

Some pundits claim that if the price of oil will fall below $30 we are headed to a global recession (marketwatch). That`s quite nonsense. Quite contrary, an oil price below $30 would be a great boon for the global economy.

                                                What Does History Tell Us?

Falling oil prices work like a tax cut. Consumers have more money to spend for other goods & services. Dropping energy prices translate into lower transport costs - thanks to cheaper Diesel - which lead to lower prices for food and other goods. They also reduce the cost to produce steel, cement and many other energy intense goods. Many things which are made from oil, like cleaning fluids, laundry detergents, paint, pharmaceuticals, cosmetics, hygiene products, diapers & plastics, also get cheaper. So, cheap oil translates into low inflation which allows low interest rates.

History shows that periods with cheap oil are periods of economic prosperity while oil price jumps are usually followed by recessions. In the early 1970s the oil price jumped because OPEC cut production sharply (chart above). This lead to two recessions and decade of stagnation. In the first half of the 1980s the oil price collapsed because Saudi Arabia flooded the markets (as today). This induced a period of cheap oil and other commodities till around 2003. Cheap commodities in combination with falling interest rates and a technological revolution (Internet) lead then to a period of prosperity (with the exception of 1992 as the first Iraq war caused an oil price spike which caused  a mild and short-lived recession), the longest boom in U.S. history (factcheck). In 2003 the price of oil started to climb again because of the Iraq war, other conflicts in Middle East and a massive financial speculation in commodities (driveby). The price of oil peaked at $146 in summer 2008, followed by a sharp recession (econbrowser). The high oil prices from 2009 through 2014 (above $110) were accompanied by a sluggish economy. 

The current oil flood and the return of cheaper oil reminds of the mid 1980s, which was he begin of an epoch of economic prosperity with low inflation & interest rates. I believe that the current oil flood will continue thanks to the technological progress which raises efficiency and reduces cost of oil production. Cheap and abundant oil will fuel another period of global economic growth. Enjoy.

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