It’s hard to believe, but western economies have had some good news recently. The slump in the oil price should raise our real incomes and hence spending.
We can quantify this. The UK consumes 1.6m barrels of oil a day. This means that the $30 per barrel fall in the oil price that we’ve seen so far this year would raise our real incomes by over £13bn if it is sustained for 12 months. That’s 0.6 per cent of GDP. The impact on other western European economies would be similar. And the benefit to the US – where oil consumption is disproportionately higher – would be even greater.
Americans used to say that "what’s good for General Motors is good for America". They never said "what’s good for Exxon is good for America". There’s a reason for that.
Every silver lining, however, has a cloud. The drop in the oil price has four of them.
One is that the fall isn’t due only to Saudi Arabia increasing its supply. It’s also a reflection of the fact that world demand for oil will be significantly lower than we expected at the start of the year as the coronavirus depresses demand not just for travel, but also for goods and services generally. The lower oil price won’t save many airlines from bankruptcy.
A second problem is that any sharp economic change causes dislocation. As Abhijit Banerjee and Esther Duflo show in their recent book Good Economics for Hard Times, economies are “sticky”: industries do not expand easily when conditions permit. This is especially true now. Ordinarily, a lower oil price would cut the cost of oil-intensive activities and thus help boost output. But because the coronavirus is depressing demand for overseas travel, this won’t happen to the extent it otherwise would. One of the channels whereby a lower oil price raises activity is thus blocked.
Thirdly, the lower oil price creates losers even in western economies. Kallum Pickering at Berenberg Bank says it will “squeeze the balance sheets of some heavily indebted US energy companies”. That threatens to cause losses for the funds holding oil companies’ bonds and for banks, if such companies default. This will provide a further test of the resilience of the financial system, at a time when we don’t need it.
Fourthly, the lower oil price will of course hit the revenues of oil exporters. You might not cry yourself to sleep over this, but it does have a knock-on effect. It will depress demand for those western assets into which oil exporters have recycled their revenues, such as bonds and high-end houses. The global savings glut will therefore diminish. Insofar as this has been a cause of falling bond yields we might therefore see rising yields, once the current phase of heightened risk aversion passes.
The fall will also, of course, weaken oil exporters’ economies, perhaps so much as to threaten political unrest. Which is a reason to suspect that the low piece might not be sustained. As it does real damage to exporters, they might take steps to restrict supply to support the price.
Yes, the lower oil price is to be welcomed. But it is not a wholly unmixed blessing.
