Sunday, January 3, 2016

Economy: Oil Price Drop - Lost In Translation?

(Drivebycuriosity) - "There have been four sharp increases in the price of oil in the past four decades – in 1973, 1979, 1990 and 2008 – and each has led to a global recession", writes the "The Guardian" (theguardian). "By that measure, a lower oil price should be positive for the world economy", comments the news service. Indeed, history shows the oil price collapses have been followed by periods of strong economic growth: "A commodity bubble has deflated three times in the past 100 years: the first was after world war one; the second was after the 1980s oil shock; the third is happening right now” (theguardian).

But the current oil price collapse didn´t rekindle the global economy so far,  in 2015 the global economic growth was still anemic. Lost in translation?

I think it needs time till the price reductions trickle through the system. Market prices are responding slowly to changed market conditions. Consumers don´t buy crude oil, they buy gasoline instead. Gas & diesel prices have been falling much slower than the prices of crude. Today Brent Crude, the international traded type of oil, costs about 30% less than a year ago ($51) and about 70% less than January 2014  ($111  bloomberg). US drivers pay on average about 10% less than last year at this time ($2.20) and around 40% less than January 2014 (fuelgaugereport). The price of diesel also dropped slower than the crude price.

                                                             Global Tax Cut

It needs time to transport crude oil to the refineries where it gets processed into gasoline and other oil products like diesel & heating oil. More time is needed to transport gasoline & diesel to the gas stations all over the nation.

There is a kind of ratchet effect. Refineries and gas station owners (often parts of vertical integrated oil companies) are happy to hike their prices when the market price goes up. But they are reluctant to reduce prices (like every producer) because they enjoy the higher profit margins. Over time competition usually forces them to adapt their prices, but that need months.

Often refineries are temporary shut down for maintenance. This gives the oil industry the power to behave like a cartel and keep the supply of gasoline scarce - at least temporary (even if the supply of crude oil rises). In 2016 the refineries earned stellar profits because of the growing difference of crude and gas prices. But I think that competition will force them to lower gas prices further.

I suppose that brent crude will stay cheap in 2016 and beyond thanks to the oil glut and the rising global production animated by technological progress. Cheap oil should execute a continuous pull on gas and diesel prices.

Over time cheaper gas & diesel prices are spreading to other industries. Airlines, bus companies and other transporters spend less for fuel. Over time competition will force them to reduce their fares.  Farmers in India, Brazil and elsewhere will spend less for diesel and also for fertilizers and pesticides that are made from oil which should translate into bigger harvest and falling food prices. And transport costs for food, building materials and everything else are falling.

"The Telegraph" calculates that already "almost $2 trillion of annual stimulus from cheap oil" is working through the global system (telegraph) - a gigantic global tax. I think that this is enough stimulus to rekindle the global economy this year. The year 1986 had a similar oil price collapse that started a decade of cheap oil and economic prosperity which lasted till the year 2,000 (driveby). Cheers to oil price collapse.

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