Oil and the Global Economy–the New Environment

The Impact of Shifting Oil Prices and the Global Economy

The dramatic decline in oil from more than $100 a barrel to less than $50 was due to a supply side shock, much more so than decelerating global demand, and the result will be broadly beneficial for the global economy as a whole—though it is of course negative for oil exporting countries. More robust global growth, as well as a pullback in investment among energy companies, should realign demand and supply and lay the seeds of an oil price recovery.
Those were some of the main takeaways from a recent Access GE webinar entitled “Oil and the Global Economy—the New Environment.” During the session, Marco Annunziata, Chief Economist, GE, and Michael Farina, Senior Market Development Leader, GE Oil & Gas, discussed the causes behind the drop in oil prices, how this will impact global growth and what the future may hold over the next 18-24 months.
Key Takeaways
  • The drop in oil prices due to supply side shock has resulted in a new environment for the oil and gas industry.

  • More robust global growth, in addition to a pullback in investment among energy companies, should realign demand and supply and lay the seeds of an oil price recovery.

  • The faster the market corrects itself, the faster prices will move back to reinvestment levels.

  • Going forward operators will become more open to experimenting with technologies to drive further efficiencies and maintain capital flexibility.

Oil and the Global Economy

The Cause: Supply Shock
While some have blamed decelerating global oil demand on China’s own decelerating growth, Annunziata strongly disagreed with that assessment. He noted that a Chinese economy growing at 7% today is much larger than the Chinese economy growing at 10% several years ago. “Even though the growth rate is going down, every year the additional size of China’s economy is bigger, and that is what matters for absorption of oil supply.” 
According to both Annunziata and Farina, the primary culprit behind oil’s decline is not softening demand but a supply shock. Three major supply factors converged. First and foremost is North American production growth, which has overtaken Saudi Arabia. At the same time, oil production in trouble spots such as Libya and Iraq did not fall as had been expected. Finally, was OPEC’s decision to keep production steady to maintain market share and not defend prices with a production cut. (See Exhibit 1: How we got to $50 a barrel)

oil-exhibit-1Exhibit One: How we got to $50 a barrel

The Effect: Improved Global Growth
Annunziata said that, without question, the decline in oil prices is a good thing for the global economy. In the U.S., the 45% decline in gasoline prices functions like a huge tax cut for Americans, whose spending contributes 70% to GDP. When you figure that 3% of their spending is on gasoline, the drop in gas prices frees up about 1% of GDP that can be directed into other areas of the economy. In terms of global growth, he expects the decline in oil prices to boost growth by an additional 0.5% to 0.7% in 2015 and 2016.
He also downplayed concerns about the deflationary effects of lower oil prices. Not only do low oil prices help economic growth by giving consumers and business more purchasing power, the dampening effect on inflation gives central banks added maneuverability to keep interest rates lower for longer to stimulate growth.
The Near Future: Adjusting to Lower Prices
That’s not to say there are no losers in this new oil environment. Countries that depend heavily on oil exports will need to keep a sharp eye on their fiscal breakeven points—the amount per barrel they need to balance their budgets. For many countries that number is above $90 per barrel. In the short term, that disparity won’t be a major problem. “But if oil prices stay low for a length of time there will need to be significant adjustments in budgets and expenditures in a larger number of countries,” Annunziata said. (See Exhibit 2: Fiscal Break Evens)

oil-exhibit-2Exhibit 2: Fiscal Break Evens

Meanwhile, energy companies are concerned with the profitability breakeven point. Farina stressed that this is a very difficult number to determine. “There is no single number for a particular producer” due to the continuing effect of new technologies, the varying ability of companies to manage assets, as well as the number of hedging strategies in place. That said, companies in North America are rapidly pulling out of higher cost plays. Farina noted that from September to January the oil rig rate dropped 25% to 1220.
The Longer Term Outlook: What is Normal?
The difficulty with gauging where oil prices are headed is that there is so much uncertainty around what a “normal” oil environment looks like. Since 2010, the price of oil has been mostly around $100 per barrel. But was that level a true reflection of supply and demand, or did the vast liquidity in financial markets artificially keep the price high? Will the new and more efficient technologies developed for example in shale oil exert a more prolonged dampening impact on prices? Will OPEC have a change of heart and reduce production? The high degree of uncertainty on several interrelated elements—macroeconomic, technological and geopolitical—makes any forecast extremely difficult and subject to a large margin of uncertainty.
Farina said one thing is for certain, the faster the market corrects itself—to whatever level—the faster prices will move back to reinvestment levels. He expects that going forward operators will become more open to experimenting with technologies to drive further efficiencies and maintain capital flexibility. A combination of disruptive technologies, the need for collaboration and a certain urgency to find solutions will lead to a “strong period of innovation over the next two years in the oil and gas industry,” Farina said. 
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