Download Oil Price Slide - Brewin Dolphin

Insight
21 January 2016
Oil price slide
adds to pressure
on markets
The price of oil has fallen below $28 a barrel this month,
the lowest since 2003, and the sharp fall has contributed to
volatility on financial markets.
One of the causes is a glut of oil which means that over time
cheaper energy should help fuel global recovery, but as Brewin
Dolphin Head of Research Guy Foster explains, the other cause is
weak demand and that is what is causing nervousness on markets.
The International Energy Agency’s (IEA) monthly Oil Market Report asked the question: can the oil price go lower from here?
It answered emphatically: yes! The IEA believes the latest slump comes from weak emerging markets whose declining
currencies mean they are not enjoying the full benefit of weaker growth and the impact of lower US dollar oil prices.
Canary in the gold mine?
It does seem perverse to imagine that price would be a big deterrent to demand given the scale of falls in the dollar price.
The energy price has fallen 70% whereas the sharpest of the emerging market currency falls are around 45% over that
period. Oil is cheaper for everyone. Now investors are looking at the oil price as the canary in the gold mine whose death
might foretell a weaker trend of economic growth for the future.
Brent crude fell below $28 a barrel at one stage this week, down from $115 in summer 2014. Lower energy prices reduce
costs for the vast majority of consumers and businesses and over time should act as a stimulus to economic growth.
Oxford Economics has estimated that every $20 fall in the oil price increases global growth by 0.4% over the following
three years.
Historically, low oil prices have generally acted as a fuel for growth, such as in the 1980s and at the end of the last decade,
but it does take time for consumers to believe in structurally lower energy prices and therefore become willing to spend their
new-found wealth.
Some commentators are talking about a new oil crisis. The crisis of the 1970s was one of soaring oil prices which triggered
an economic downturn. This time round the fall in oil prices appears to be a symptom of weakness in the global economy
and over time lower energy prices should be part of the cure that helps recovery.
Why has the price of oil fallen so sharply?
It is a good example of market forces at work as weaker demand, from a slowing global economy and a weaker China,
have combined with a surge in production to force prices down.
World oil output has been running at record levels following the revolution caused by the US shale oil industry. The new
forms of non-OPEC supply have destroyed the cartel’s pricing power. Members, Saudi Arabia included, are now best
served by maximising production despite the low price, as to do otherwise would gain them nothing in profit margin but lose
them market share, particularly to their regional rival Iran which rejoins the market following the lifting of sanctions.
Winners and losers
The global economy should be the winner, but, as we have discussed, it may take time for the effects to filter through.
Energy users, whether countries, industries, companies or consumers, should benefit from lower costs and prices. Lower
oil prices are a form of stimulus to the broadest possible swathe of businesses and households.
That goes for advanced economies and emerging economies, many of which will see their public finances improve because
they will be able to reduce fuel subsidies.
Falling prices are bad news for oil producers and exporters, with Venezuela one country already showing signs of financial
distress.
However, the picture is often mixed and in the UK, for instance, while low oil prices will be cheered by many, it means lower
profits for the oil and gas industry which is an important contributor to our economic performance and a valuable source of
income for the Treasury.
For the US, the impact is mixed because it is both the world’s largest producer and consumer of oil, so any price fall may be
a general boon to the economy, while forcing the shale industry to cut back on investment. At the same time sales of sports
utility vehicles are soaring and motoring has picked up in response to the lower price of fuel. As cheap oil helps hold back
inflation, it encourages the Federal Reserve to be cautious about the pace at which it increases interest rates.
Oil companies are already seeing an impact on their profits and one result of this is that investment in new projects will be
scaled back until market conditions improve. This forms part of the automatic stabilisation mechanism that sees weaker
prices curtail new supply, bringing the market back into balance.
The value of investments can fall and you may get back less than you invested.
Past performance is not a guide to future performance.
If you invest in currencies other than your own, fluctuations in currency value will mean that the value of your investment will move
independently of the underlying asset.
The information contained in this document is believed to be reliable and accurate, but without further investigation cannot be
warranted as to accuracy or completeness.
The opinions expressed in this document are not necessarily the views held throughout Brewin Dolphin Ltd.