The price of a barrel of oil has slipped by almost 40% in the last few months (from $115 to $70). This is primarily due to three reasons:
- The global economy is consuming less oil
- OPEC has started producing more oil
- The US has been producing shale gas much more effectively and efficiently. In fact, ‘fracking,’ a term used for extracting shale gas from underground rocks, has been so successful in 2014 that the supply of oil and gas in the US market has gone from 0.5% to 3.7% of the global output.
Good News for Some
For the most part, this price drop is viewed favourably. Oil-price is a significant contributor to price levels in the consumer basket (i.e., if supply chain costs are reduced, the final product is less expensive). Consumers can see the correlation between a drop in oil prices and overall spend on daily consumables quite rapidly.
Countries such as China (one of the largest importers of oil) and India (which imports 75% of its oil requirements) view this as a blessing. A reduction in import bills helps India manage its current account deficit with greater ease.
Not-so-Good News for Oil-Producers
Although all of this should contribute toward the growth of the world economy in the long run, it has a potential adverse and significant impact on oil-producing countries. These countries are now faced with the risk of either having their economies de-stabilised or run the risk of defaulting on their debts (from Russia to Venezuela).
Reduced oil prices can stifle growth plans for oil-producing countries/companies, as they will start pulling out from their strategic investment decisions to produce more oil.
Some estimates suggest that up to £55bn worth of North Sea oil projects scheduled for 2015 may be pulled out as a result of price decline.
Saudi Arabia, which has the lowest production cost in the world and savings of $900 billion, is an exception as it can easily afford to continue being the dominant OPEC player even at the oil price of $70.
Russia, which is one of the largest oil producers in the world, has seen a sharp increase in its interest rates (17% currently) and a severely impacted currency. The World Bank has recently warned that the Russian economy will shrink by 0.7% in 2015 if the oil prices remain at $70 per barrel.
Venezuela is already witnessing an inflation of 60% and an unsettling population.
If the rate does remain at this level, some of the de-stabilised economies may begin witnessing a different mix of risks from collapse in the financial markets to K&R…
Food for thought: Who else may be impacted if the energy or utilities sector starts to see a downward revision in their growth projections?
Guest blogger Sumit Mehra is the Finance Director for Risk & Analytics. He previously managed strategic and financial planning for Willis UK businesses. Prior to joining Willis, he worked with global firms in supply chain and strategy consulting. Sumit has an MBA from London Business School and a Bachelor’s degree in economics.