Oil Price Slump Leads to Further Economic Strain

By John Gallagher,
International Business Assistant Editor

Thus far in 2016, financial markets are off to their worst start in at least two decades spurred by a plunge in the price of oil to under $30/ barrel and concerns about global growth.

Developed economies; namely EU countries, the United States, and Japan have been growing steadily at around 0-2 percent.  The world economy had been expanding at a slow steady clip, but according to Statista, it is projected to have shrunk in 2015.  This can be attributed to the decrease in GDP in many oil producing developing countries.

High oil prices spurred investment and growth in oil rich countries and were a main driver behind global growth in the first half of the decade.  The drop in oil prices has erased economic progress experienced during times of $100 oil, and is putting incredible stress on lenders who financed oil exploration projects during periods of high oil prices.

OPEC, the Organization for Petroleum Exporting Countries, recently rattled markets with the announcement that they were not cutting their production in an effort to drive other oil producers out of business and maintain their valuable market share.

The decision by OPEC to keep their foot on the gas has had crippling effects on some members of the cartel, namely Venezuela and Nigeria.  Venezuela currently has the most miserable economy in the world and is suffering hyperinflation of 140% coupled with an economic contraction of over 7 percent in 2015.  Nigeria’s oil production accounts for 70 percent of the government’s revenues and 95 percent of export earnings per The Economist.  The Financial Times reported that Nigeria’s government requested $3.5 billion in funding from the World Bank and the African Development Bank to help cushion the blow of low oil prices.

Many people outside of the world of finance think that low oil prices are good for the economy.  The average gas price in the United States is down to $1.80 per gallon, saving consumers billions of dollars over the course of a year.

The savings at the pump should, in theory, boost consumer spending and boost the earnings of non-energy sector companies.  A Bloomberg report cited a research paper published by the Federal Reserve Bank of Dallas that a drop in oil prices brought about by rising supply- like the current one- should boost global growth by up to 0.4 percentage points.  “This is mainly due to an increase in spending by oil-importing countries which exceeds the decline in expenditure by oil exporters,” the paper said.

To dispute that assertion, the IMF reported that the pickup in consumption from the drop in energy prices has had less of an impact than previous periods of low oil prices.

Consumers’ money hasn’t yet translated into increased growth in the United States.  Rather oil companies have seen profits slashed and have had to borrow to pay dividends to their shareholders, resulting in downgraded credit ratings.  Exxon Mobil still maintains the prestigious AAA credit rating but they are cutting 25 percent of their spending on rig leases, floating oil platforms, gas terminals, and other exploration and production projects until oil prices rise to profitable levels.  Energy stocks have plummeted due to low oil prices and equity indexes have been dragged down by concerns over global growth, brought about by low oil prices.

As a United States consumer (who isn’t heavily invested in the markets), all seems to be well.  The reality is that there are many countries that are struggling to pay their debt and finance their government because oil prices are still lingering at an unprofitable level.

A version of this article appeared in the Tuesday, February 9th print edition.

Contact John at
john.gallagher1@student.shu.edu

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