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The causes and consequences of the oil price collapse
The price of oil has plummeted since June, by more than 40% in dollar terms and more than 30% in euro terms. And the trend has gathered speed in the last few weeks. So why has this spectacular fall occurred now? Who stands to win and lose from a sharp drop in the oil price and what are the likely consequences on growth and inflation in the euro zone and worldwide?
A question of supply and demand
The oil industry has undergone a structural change in recent years with the rise of shale oil extraction. Shale oil production in the USA is now around four million barrels a day, accounting for close to half of total domestic production. The development has significantly reduced US dependence on oil imports and the country could even become a net exporter in the coming years. At the same time, production in the Organization of the Petroleum Exporting Countries (OPEC) member states has remained strong despite considerable recent geopolitical tensions. The OPEC as a whole continues to produce around 30 million barrels a day.
While world production has increased sharply, the same thing cannot be said about demand over the last few months. World growth has proved disappointing compared with forecasts at the beginning of the year, especially in China, which is one of the world's biggest importers of commodities in general and oil in particular.
In the face of this growing mismatch between supply and demand, the OPEC meeting on 27 November was a key moment. To the surprise of many observers, OPEC decided to not reduce oil production, a move that sent the oil price plunging to a level around 60 dollars a barrel. At that kind of price level, some shale oil producers could find it hard to cover their production costs in the long term and one has to wonder whether OPEC is trying to reduce the market share of shale oil producers. But the price contraction could also prove costly for the OPEC countries. The risk is primarily a political one, as many of the member states' current promises on public spending are predicated on prices above 100 dollars per barrel.
Impact on inflation and growth
A drop in the oil price directly reduces inflation through the energy price component in price indices. It may also indirectly reduce inflation through lowering production costs of other goods and services and transport costs. As such, it could also have a negative effect on core inflation which excludes food and energy prices. This will not make the European Central Bank's (ECB) task any easier in the short term. The ECB is up against near-zero inflation and has already made a substantial downwards revision to its inflation forecast for 2015 to 0.7% (this represents a downward revision of 0,4% relative to its September forecast), following 0.5% in 2014. It should also be noted that these revisions do not take account of the latest oil price decrease since the OPEC meeting. In Luxembourg, these impacts will also be felt by a sharp decline in inflation.
In terms of growth, the positive effects of the oil price slide are to be found in the increased purchasing power of households and reduced production costs for businesses outside the petroleum sector. These positive impacts are likely to be substantial in the euro zone, which is good news in what is still a fragile growth environment. The impact of the oil price decrease will naturally be different for oil-exporting nations such as Russia, Venezuela, Mexico and Norway, where growth will suffer. Worldwide, apart from the euro zone, it is mostly in the USA where consumers and firms stand to benefit from the fall in oil prices.
Sources: Macrobond, BGL BNP Paribas
BGL BNP Paribas
Published in the Luxemburger Wort (in French) on 18 December 2014.