Every morning I record a podcast in French (see here) on a specific topic. The text below is the translation of this morning podcast.
The drop in oil price will have a salutary effect on the economy of the Euro Area.
The lack of commitment between oil producers at the OPEC meeting in Vienna on Thursday the 27th implies a continuous slide in the oil price.
This situation reflects a very peculiar situation on the oil market which is in excess supply. Demand’s dynamics is limited because of the gloomy global growth momentum. At the same time, production is at a high level. Every producer tries to improve its revenues by increasing its own production or by maintaining it at a high level.
An agreement in Vienna between OPEC countries would have been important as the global OPEC production would have been stabilized. Excess supply would have been reduced and the price could have then followed a more stable path.
This will not be the case. The lack of agreement suggests that none of the OPEC members wishes to be constrained in its behavior. This reflects a new balance of strength within the OPEC. Saudi Arabia doesn’t want to regulate the oil market as it did in the past. Russia wants to produce more like a lot of other countries in a context of low revenues due to a poor macroeconomic environment.
Without an agreement an average producing country has no interest to produce less. It would reduce its revenues. As other countries continue to export, the oil price will continue to slide and as its production is lower this country would have lower revenues. With an expected reduced price pattern this country must continue to produce and may be will it be tempted to produce more?
That’s the paradox of the current situation. By acting individually a country takes the risks to see a reduction of its revenues while it could be stable for the other countries. The best strategy is probably to continue to produce and to follow others’ behavior. The revenues’ profile will follow others’ profile. And the price continues to fall; its revenues will fall as others’ revenues.
A situation of this type has already be seen in the past. In the mid-80’s, no agreement was found between OPEC’s members and in 1986 the oil price dropped dramatically. It went from 27.6 USD in 1985 on average to 14.48 in 1986 and remains below 20 USD until 1989. This rapid drop has been a real boost for growth in oil importing countries. It was a trigger for the strong growth episode of the second part of the 80’s.
A deep drop in the oil price is a transfer from oil producer countries to oil consumer countries and leads to a rapid improvement for the latter’s. Companies’ margins improve rapidly specifically in the industrial sector and the improvement can be perceived for households as their invoices for gasoline and fuel can be reduced dramatically. Due to the inventories’ management, there are delays sometimes but usually the oil price and energy price in the CPI index have consistent behaviors.
This is good news for the Euro Area as it will create new arbitrage in companies and households’ budget. It will be a strong support for the economic activity and will be a growth revival.
Critics say that lower revenues for exports countries would lead to lower world trade and a negative impact on global growth. That’s no big deal because the rapid improvement in developed countries would outweigh this negative impact.
Lower oil price would also mean lower gasoline price and fuel and so lower revenues for national budget in developed countries. Again higher VAT revenues would compensate these lower receipts.
A lower oil price has a lot of virtue in the current context for the Euro Area. It could be salutary.