LOWER OIL PRICES:GOOD NEWS, OR BAD?
The past months have been marked by weaker oil prices, with the Brent breaking decisively below USD 80/barrel, and now sitting at a record 5-year low of USD 68/barrel. With the lack of agreement among OPEC members to cut output, and subdued demand in a low potential growth environment, investors should probably factor in durably lower oil prices than they have been used to over the past 3 years. Is this good news or bad news?
Let’s consider the largest consumer in the world: the US economy. Although lower oil prices have historically been generally positive, not all periods of falling oil prices have led to an accelerating economy. Indeed, while lower prices coming from rising supply with resilient demand are good, declining demand is worrying. So, which is it today? Despite a small seasonal downtick in world demand in October, rising supply has clearly been the prevailing factor driving prices down over the past few months (Chart 1). As long as this is the case, lower oil prices are positive for energy consumers.
As regards the US, it is argued that lower oil prices will not benefit the country, which produces and exports much more energy than in the past. While we acknowledge this fact, it remains nonetheless a net energy importer, and a fall in Brent prices from USD 115/barrel to 70 represents an annual savings for the country of 0.4% of GDP. While it would have been greater in 2006 (1.0%), it remains far from negligible, especially with lower global potential growth. In addition, domestically, lower oil prices create a wealth transfer from the producer to the consumer. As the latter accounts for almost 70% of GDP and has a larger propensity to transform savings into expenditures than producers, the GDP boost will be magnified.
What about the rest of the world? Who are the winners, who are the losers? Net oil exporters will obviously suffer, while net oil importers will benefit. Chart 2 ranks 33 of the major world economies according to the size of their oil surplus/deficit. Not surprisingly, the Middle East will be the largest loser, although the region is immunised by its large fiscal surpluses. The situation in Russia is far more problematic, and the collapse in oil prices will certainly accelerate the country’s fall into recession. That said, the majority of the world economies are net oil importers/consumers and will therefore benefit from the slump in oil prices. As such, a further step towards discerning the prime winners is to look at the share of energy in their consumer price indices: the larger, the better. Chart 3 shows that India and some South East Asian countries are well positioned (Indonesia, Thailand). Turkey should also welcome lower oil prices as a means to reduce its large current account deficit and to better control inflationary pressures. Finally, Eastern Europe (Poland, Hungary, Czech Republic) as well as some core European countries (Spain, Germany) will get a nice boost from cheaper oil.
So, all considered, lower oil prices are a net positive for the global World economy. What opportunities on the investment side? Lower energy prices support consumers’ purchasing power. In the US, periods of negative oil returns have historically been associated with periods of outperformance of the MSCI Consumer Discretionary and Staples equity indices over the MSCI US equity index (Chart 4). An exposure to the US Consumer therefore appears to be a direct way to benefit from lower oil prices in USD.