For the final 75 years, almost every financial crisis has been preceded by an oil price spike. Worries now’s that low energy costs are pushing the global economy right into a tailspin.
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While the concept is counter-intuitive, it’s gaining traction because a growing share of the world’s consumers and investors have been in the very places getting hammered through the rout in commodities prices. Apple Inc., for example, blamed weaker sales last quarter on lower economic growth in some oil-rich countries.
“Never imagined I would wish, let alone pray, for higher oil prices, however i am,” said Han de Jong, chief economist at ABN Amro Bank NV in Amsterdam. “The world badly needs higher oil prices.”
The issue is that the world’s economy relies much more today on emerging countries than 15 or 25 years ago – the last periods of ultra-low oil prices. In another twist, the U.S. has emerged to vie with Saudi Arabia and Russia as the world’s biggest oil producer. In the past, the injury done to exporters was a lot more than offset by importers’ gains.
And except for China and India, most big emerging countries are oil and commodities rich. Such economies now account for about 40 percent of global gdp, about double their be part of 1990, based on the International Monetary Fund.
From Russia to Saudi Arabia, Nigeria to Brazil, economic growth is slowing down to a crawl and, in many cases, is contracting.
“Many oil exporters face very hard circumstances,” said Gian Maria Milesi-Ferretti, the IMF’s deputy director of research. “Now they need to cut spending significantly, and will also have an impact on economic growth.”
I i never thought I’d wish, let alone pray, for higher oil prices, however i am
The predicament is so dire that sovereign default, for long a forgotten possibility, has returned on the table. “History provides reason behind extreme pessimism on the likely fortunes of commodity producers,” said Gabriel Sterne, head of worldwide macro research at Oxford Economics Ltd. In the 1980s, when oil prices fell below US$10 a barrel along with other commodities plunged, “producers that avoided sovereign defaults were the exception rather than the rule,” he explained, noting 68 percent of those he monitors defaulted.
The market sees Venezuela, among the world’s top 10 oil exporters, like a likely default candidate. Its bonds maturing in 2022 trade at 38 cents around the U.S. dollar and yield more than 40 per cent. In 2013, the yield was below 10 %.
The IMF and also the World Bank are already in talks with Azerbaijan and Suriname to supply emergency loans. Nigeria has additionally asked the World Bank and also the African Development Bank for help.
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To be sure, oil may find a floor when the world economy does. The slowdown in China has reduced its interest in commodities, meaning stabilization there could prompt crude to rebound.
Some aren’t worried whatsoever. The U.S. Fed Bank of Dallas, inside a research paper released in January, asserted a stop by oil prices brought about by rising supply – like the current one – should boost global growth by up to 0.4 percentage points. “This really is mainly due to an increase in spending by oil-importing countries, which exceeds the decline in expenditure by oil exporters,” the paper said.
Indeed, the market is focusing on the short-term adjustments and ignoring the potential gains, according BlackRock Inc. Chief Executive Officer Laurence D. Fink.
“The truth is 4 billion human beings are going to have cheaper energy, cheaper heating, they’re going to have more disposable income,” Fink said recently. “And eventually that’s likely to re-accelerate the worldwide economy. It might take six months, it might take annually however this is all good.”
Francisco Blanch, commodities analyst at Bank of America Merrill Lynch, argued that the sustained oil price plunge “will break the rules $3 trillion annually from oil producers to global consumers, setting the stage for one from the largest transfers of wealth in history.”
So far, though, consumers in civilized world aren’t behaving because they should: spending the windfall from cheaper energy. This time around, “the pickup in consumption in oil importers has so far been somewhat weaker than evidence from past episodes of oil price declines might have suggested,” the IMF said in January.
The reason: cash-strapped individuals are using the savings to settle debts. JPMorgan Chase & Co. economists estimate U.S. households, for example, spent less than half their extra money.
Low oil prices have prompted companies to cancel a large number of capital-intensive projects – like drilling wells – which in turn means lower demand for machinery. Wood Mackenzie Ltd., a business consultant, estimates that at least US$380 billion has been put on hold. IHS Inc. puts it at around $1.5 trillion.
Whatever the total amount, the IMF says the outcome on investment in oil and gas new projects is “subtracting from global aggregate demand.”
Bloomberg News
