Share the article
twitter-iconcopy-link-iconprint-icon
share-icon
Editor’s blogJanuary 14 2015

Falling oil prices are a slippery slope

While consumers are celebrating the recent fall in oil prices, the political and economic ramifications are threatening to destabilise a number of oil-producing economies.
Share the article
twitter-iconcopy-link-iconprint-icon
share-icon

Sudden market movements are destabilising even if in the medium term they are in the right direction. For this reason, there have to be concerns as well as plaudits over a 50% drop in oil prices.

Of course, lower energy prices are positive for both growth and government budgets in oil-consuming countries. A 10% fall in the oil price may translate into about a 0.1% growth increase in Europe, while countries such as India and Indonesia are using this as an opportunity to reduce the fuel subsidies that hammer their budgets.

But the risks are that marginal producers, such as those in the UK’s North Sea and the new US shale producers, may not be viable at current prices. If they cut back or pull out, the fall in supply risks sending the oil price straight back up again. Banks with exposure to marginal producers should probably be reviewing these loans.

Pushing over marginal producers is presumed to be the strategy of Saudi Arabia, which successfully opposed moves by some Organisation of the Petroleum Exporting Countries members to reduce output. Saudi Arabia prefers to see the price fall, at least for now.

But how long can the oil exporters last out at the current price? Budget statistics suggest not very long. Even Saudi Arabia’s budget needs oil at $104 in order to balance, whereas benchmark Brent crude has fallen below $50 a barrel, and while Saudi has huge financial reserves to fall back on, other countries will find the going tougher. Libya needs an oil price of $184 a barrel to balance the books, Iran $131, Algeria $131, Nigeria $123, Venezuela $118 and Russia $105.

As a result, there is speculation about a debt default in Venezuela and political crisis in Russia. With Iran there are hopes that lower oil prices might drive the government to do a nuclear deal with the US that would lead to a lifting of sanctions. But on the whole, the political ramifications of oil price-induced budgetary problems are more likely to be negative.

Meanwhile, research from Scotiabank suggests that US shale producers need a $60 barrel to stay in production. As shale production offers the best prospect of relief in an energy constrained world, this would clearly be a strong negative.

So the good news for consumers – and the demand push it creates as they spend their extra cash – has to be balanced against the challenges for producers. The fall-out from the sudden oil price drop will one of the biggest factors affecting both economics and politics in 2015. ​

Brian Caplen is the editor of The Banker.

Was this article helpful?

Thank you for your feedback!