NEPIC CHIEF EXECUTIVE WARMS OF WIDER ECONOMIC IMPACT OF LOWERING OIL PRICES

THE Boss of BP recently told the BBC that low oil prices will persist for three years. Furthermore, the continued lowering of oil prices has been welcomed by many consumers as their transport fuel and other domestic energy costs have declined. However the wider economic impacts need to be appreciated because these are not always clear from a cursory glance at the daily economic news. Indeed the fact that we have a short-term economic gain is probably masking severe problems ahead.

If low oil prices persist, the industrial supply chain impacts in a number of industries will turn out to be devastating if not terminal. Furthermore, the resulting outcomes for the global economy, because economies are so interconnected today, will bring other negative impacts from elsewhere that can so very rapidly land at your own front door. Two thousand Redcar steel workers in the UK can attest to that.

The economic fallout clearly has a direct impact on the many countries that rely upon oil and gas as the major contributor for the wellbeing of their economy. The Middle Eastern nations, Norway, Russia, Venezuela, Scotland, Nigeria and Angola are a case in point but wider impacts soon occur as international economic interconnections begin to flex. The impact eventually gets reflected in currency fluctuations, the price of other commodities, the cost of consumer and industrial goods and trade interactions exports and imports. These can weaken the global economy, far outweighing the initially perceived consumer cost benefits.

Some commentators suggest that oil prices in 2016 could go even lower than those in 2015. This is because the world’s stockpile of oil has continued to rise and, despite the low price, production has not declined enough. American production of shale oil for example remains above 9m bbl/d and with OPEC’s loss of control over the actions of its members their output has risen to 31m bbl/d.  Declines elsewhere, like in the UK and other smaller oilfields, have been insufficient to rebalance the market. The whole situation is beginning to look a bit like the “OK Coral” with the big producers watching and waiting for someone to make the first move.

Analysts suggest that there won’t be any significant production decline until the last quarter of 2016, however this is just a guess, as predicted recent rises have had to be revised downwards. It is thought that average prices in 2016 might remain above those of 2015 but many fluctuations are implied with US$20/bbl being possible. The benefits of low oil prices to manufacturers are not uniformly positive and there will be winners and losers.

For instance, sectors that use large volumes of imported materials could benefit as transportation costs fall and overseas suppliers pass on these benefits. However, sectors that operate in export markets may experience increased competition from businesses that can now compete on price in these markets due to lower production and transportation costs.

Winners are likely to be the oil-intensive and energy-intensive manufacturing sectors, such as cement, chemicals, industrial gases, metals, machinery and equipment. This has resulted in the pound strengthening and it is beginning to make exporting more difficult for sectors up the supply chain, less energy intensive and closer to the consumer.

It is not a good time to be involved in oil production. The UK’s oil and gas sector has lost out big time with a severe contraction in output and employment during the first two years. Higher cost producers are exiting the industry or scaling back their operations. A permanent reduction in the oil price could reduce the level of GVA to the UK economy from this sector by around 8% on average between 2015 and 2020, with a peak output loss of around 12% in 2016.

Some analysts suggest that the overall impact of lower oil prices on the UK economy may well be positive, beneficially improving its baseline performance by 1.4% through 2016. Unfortunately this short-term impact is not sustained as the benefit falls to 0.6% by 2018; largely as the UK’s economy becomes more exposed to cheaper imports. The UK is not immune from global economic impacts and if low oil prices persist it will lead to a downward spiral for the global economy.

A long-term retreat from higher energy prices may result in some economies being irreparably damaged. An adjustment of the relative value of currencies will arise and lead to a lowering of the price of goods in developed countries, increasing their imports and damaging their own manufacturing capability. A lack of economic growth can also result in commodity prices that can never recover, causing a rapid and often terminal reduction in production.

The double whammy of both lower energy prices and lower prices of imported goods gives persistently lower inflation rates and ultimately low or no growth economies with greater debt and increasing unemployment. Contrary to what you might intuitively think, persistent lower oil prices will not lead to overheated economies – they are most likely to lead to a global recession.

– Stan Higgins is CEO of the UK’s North East Process Industry Cluster

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