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What would $ 25 Drop in Oil Price Mean for the Global Economy ?

October 27, 2014
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By: ASAD RIZVI   Published on October 29, 2014
I think the maths is very simple when IMF makes a frequent downward revision of global growth and IEA sees a reduction in oil demand then there is no reason to believe that oil prices will make gains in such adverse conditions. China is no more enjoying a 10 percent growth rate that it enjoyed for over last two decades. Growth in its housing sector has slowed down badly. Demand for steel from China is another indicator that its construction business is weak.

In August this year Chinese central bank was forced to inject liquidity to support its domestic banking system in local currency in equivalent of nearly three and half billion US dollars. Recent announcement from China says that its reserves are down for the first time since 1996 by USD 100 billion to 3.89 trillion. It all suggests that China has been the global growth engine, that engaged the world economies in vender financing, as Western economies could only manage to survive through liquidity injection, which is a Japanese recipe known as Quantitative Easing (QE) or else the world economies would have collapsed long ago.

In recent years, despite Fed injecting trillions of US dollars in the name of Quantitative Easing (QE), the funds did not help new businesses to flourish, though its balance expanded substantially to a record size, as most of the money was meant/spent for capital injection to correct balance sheets and plug holes. Fund managers were also the beneficiaries as they were also blessed with QE money.

Europe is once again in trouble and ECB has announced that it will be injecting funds through QE. The purpose is not to support business activity, instead banks having weak balance sheets will be blessed with this money, which means more trouble in future.

This is why during all these years no major growth was seen in the developed countries and hence, growth in corporate sector remained subdued. Basically, it’s a number adjustment game in the absence of genuine growth. Injection of money (QE) is not meant for economic stimulation, it is only to cater to financially-crippled books so that holes can be plugged to carry business as usual.

Coming back to oil, if we look at the overall geo-political conditions, in present times things are pretty calm, as Ukraine is a political scapegoat for face-saving purpose. The Iran issue, too, has quietened internationally to a greater extent, giving breathing space to Iran. The Syrian conflict has a different angle and has more to do with oil and gas pipeline/supply that had Middle Eastern (Saudi and Qatari) interest linking with Europe. But Russia for its own survival/interest that exports gas worth over USD 400 billion annually to Europe was the spoiler of the game and so far business is as usual, as the conflict may not have a spillover effect.

If we look from the oil producing countries’ perspective, increase in shale oil production is bad news and is a matter of grave concern for the rich oil producing nations. In August 2013 Prince al-Waleed bin Talal, the billionaire Saudi investor warned Saudis, with an open letter arguing the US shale gas revolution threatened its economy.

So here is an opportunity for the oil producing countries to control oil prices, when the world is not faced with a major geo-political problem. It is estimated that to be profitable shale price needs to be somewhere around $90-100, if correct, then is this not the best time to keep oil prices low and under control.

If we look at the foreign exchange reserves and investment of all the major oil producing countries, they are comfortably placed. Some of them may be carrying debt in their books and some may have to adjust their budgets, but is it not worth taking a chance at a time when the oil producing countries have a good grip on the market. They can certainly make adjustments in their next budget, rather than getting caught trapped at an odd time. Therefore, I do not see any reason for oil to make new high in near or medium-term and instead oil could lose another $20-25, which may not be very surprising unless there is another global unrest in the making.

However, for the cash-strapped world economies that have a daily requirement of 95 million barrels, a USD 30 drop annually would mean that the world will be deprived of USD 1.04 trillion cash money. This is huge amount of money and even a slash of half the amount is good enough to give jitters to the world economy. Since June, Brent oil has lost 26 pct of its value against the high of USD 115 and is currently trading at USD 85 per barrel and oil prices are still under selling pressure.

Another area that could have an adverse impact on the world economies is the foreign remittances, which is nearly USD 500 billion annually. There is every possibility that if oil prices do not recover, it will depress oil producing economies. They will have to cut their development plans resulting in slowdown in business and job losses. This will lead to a drop in remittances by nearly 10-20 percent, depending on the size of a budget cut. In such a situation many countries could face a balance of payment problem, as current account position could deteriorate.

(The view expressed in this article are not necessarily those of the newspaper)

Copyright Business Recorder, 2014$25-drop-in-oil-price-mean-for-the-global-economy.html
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