Falling oil prices to boost economy

Oil prices have been undergoing one of their sharpest declines in recent years, dropping by over 30 percent since June and pushing four-year lows.

Oil image
Source: Bloomberg

There have been two main factors driving the selloff: prospects of weak demand and oversupply.

On the demand front, the outlook has been held back by the stuttering European economy.

One of the most recent concerns has been over Germany, which has shown some signs of a slowdown with softening manufacturing and inflation numbers.

Prospects of a slower growth in China have also not helped the global picture.

On the supply end, US production has is at its highest in decades, above the nine million barrels a day, partly thanks to its shale oil boom, according to the US Department of Energy. While the world’s largest producer Saudi Arabia has trimmed its output, it has done little for oil prices as other countries step up their production.

This has seen production by the Organization of the Petroleum Exporting Countries (OPEC) push a year-high of nearly 31 million barrels a day, according to its recent data released.

Lower oil prices are good news for everyone right?

That’s true for the most part as one would expect this to translate to lower input costs for businesses. The potential trickle-down effect also means lower expenses will help household budgets grow, which should spur consumers to spend more. Overall, this would also be a positive spill over effect for the economy particularly benefiting stocks in the retail, food and beverages space.

Falling fuel prices will also benefit the airline industry. According to research by JP Morgan Chase, the industry’s forecasted 11 percent operating margins for 2014 could help rocket to a record 14 percent in 2015, thanks to lower costs from an estimated $4 billion drop in its fuel bill.

The general market consensus is that if oil prices stay around the current prices of about $80 a barrel, consumers and businesses can continue to enjoy low energy costs, while still allowing oil companies to remain profitable.

If oil prices drop under $70, this will likely make it less financially viable for oil and gas exploration or production. This could prompt a slowdown in investment and future revenue pipelines, and hit oil-related stocks. Last month, BP was among the first oil majors to report that its earnings were under pressure from lower oil prices. While Exxon Mobil and Chevron also saw a hit on production, the impact was offset by their strong refinery businesses.

What will be monitored closely next is the crucial OPEC meeting on Thursday 27 November in Vienna. This has been dubbed as one of its most important meetings in years, and the market is generally split on whether the grouping will agree to reduce supply and hike prices. With the inability of OPEC to coordinate so far, there is little optimism over any recovery of oil prices in the interim.

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