What’s the Impact of Falling Oil Prices? Only Time Will Tell

The history of oil prices is that they never rise forever and don’t fall forever. The current situation is partially the result of the oil renaissance in the US. Production has reached levels not seen since the early 1970s. This increase represents about 90% of the increase in global production this year. But, this increase comes at a time when global consumption has plateaued because of economic stagnation in Europe, slow growth in the US, and slower growth in emerging economies.

The key question to ask is how long will the current economic situation last? There is no evidence that the EU is able to adopt policies that will achieve healthy levels of economic growth and without that and higher levels of growth in countries like China and India, demand for oil products will remain weak. Economic forecasters don’t have a very good record when it comes to global growth, so we will just have to let economic forces run their course rather than listen to the experts.

In the short run, motorists, homeowners who rely on heating oil will benefit. So will energy intensive industries. However, those benefits will not persist if demand for their products doesn’t increase. The domestic auto industry will enjoy a big benefit because low gasoline prices lead to an increase in large vehicle sales that have larger profit margins.

If the decline in demand is not reversed fairly soon, one of the consequences will be a slow down in domestic production and possibly new exploration investments. The production of shale oil is high cost production. If producers can’t cover their costs, they will slow down production, if they perceive that stagnant demand will persist for some time.

Russia is already experiencing a serious economic problem because most of its foreign exchange comes from the sale of oil and gas. The effect of the drop in oil prices probably has more of an impact than the sanctions that have been put in place. Its economy is collapsing.

Historically, when prices have fallen, Saudi Arabia and other large OPEC producers have cut production to reverse the decline. So far, the Saudi’s have refused to do that and instead are pursuing an increase in market share. This undoubtedly is being driven by Persian Gulf politics.

As economic writer Robert Samuelson has pointed out we may be entering a “new era of muddle-nomics” where central bankers and political leaders are at a loss for policies that will return developed economies to robust levels of economic growth. As he points out, the debate between those who fear more debt and those who favor more stimulus can be self defeating because the public losses confidence that government knows what it is doing. In a related column, Samuelson addresses why the world economy is sputtering. Of the various reasons he addresses—over estimating emerging nations growth and the hangover from the 2008 global recession—the one that could have the most serious long-term implications is the aging population in developed countries and the costly entitlements that go with aging populations.

Whatever the reasons for the current global economic malaise, there is no credible evidence that the political elites have a clear idea of how to reverse these economically constraining trends.

All of this brings to mind, Donald Rumsfeld’s observation about knowns, unknowns, and unknown unknowns. Despite uncertainties and unknowns, there is one obvious fact. Government spending and government debt here and in other developed countries is increasing, not decreasing. Government spending has been demonstrated to be less efficient than private spending. Reversing that condition and creating incentives for more private spending would be a good start and there is no better place to start than with the pursuit of the “green agenda” here and in the EU. It has done immense economic harm.

 

This article appeared on the National Journal’s Energy Insiders weblog at http://disqus.com/wokeefe/

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