The Effect of Low Oil Prices: A Regional Tour

By: Ashley Kindergan

November 20, 2014

Brent crude oil prices hit a four-year low in November of $77.83, and Credit Suisse believes sub-$100 prices are here to stay for at least the next three years. What does the sudden and sharp decline portend for the world economy? Generally speaking, falling crude oil prices are an importing economy’s paradise and an exporter’s inferno. But the macroeconomic ripple effects are a bit more complicated.

The United States and Malaysia, for example, are both importers and exporters, meaning that the same macroeconomic trend that benefits ordinary consumers and retailers can be a headwind for energy production and have mixed effects on overall GDP. In emerging markets, countries that subsidize fuel are affected differently than those that do not. To sort it all out, Credit Suisse has detailed what low oil prices mean for major economies across the globe.

U.S.

If Credit Suisse’s energy forecasts prove correct, Brent crude will average $92 a barrel in the fourth quarter, and Americans will enjoy the equivalent of an $80 billion tax cut, the equivalent of 0.7 percent of disposable income. Credit Suisse’s U.S. economists also forecast that lower oil prices will cause annual inflation to fall from 1.7 percent in September to 0.5 percent by the spring.

A cash windfall just before the holidays is great for consumers and retailers, but for those drilling relatively high-cost wells to get at tight oil in U.S. shale beds, cheap oil prices are hardly a welcome development. The price of West Texas Intermediate (WTI) has fallen $17 per barrel since last year to just under $75, and Saudi producers recently cut prices to American customers while raising them in Asia. If WTI hits $75 a barrel, predicts Credit Suisse Global Energy Economist Jan Stuart, U.S. oil production growth could shrink from more than 1 million barrels per day to 200,000 barrels per day. (Although he also sees it reaccelerating to between 500,000 and 700,000 barrels per day in 2016.)

Japan

Can cheap oil move impassive central bankers? In a country that imports nearly every last drop of its crude oil, apparently so. Bank of Japan Governor Haruhiko Kuroda cited falling prices of oil, food, and other commodities when he announced an expansion of the central bank’s monthly bond-buying program in late October. The Japanese economy has struggled to meet the bank’s 2 percent inflation target, with the September reading coming in at 1 percent after adjusting for the effect of a tax hike in April, and Kuroda pledged an “unwavering commitment” to stamping out Japan’s two-decade struggle against deflation when announcing the more aggressive easing. While falling oil prices weren’t the only factor in the central bank’s decision to add to its stimulus, their deflationary effect was certainly on Kuroda’s mind.

Europe

Credit Suisse’s Private Banking & Wealth Management Division thinks that the European Central Bank may well follow Japan’s example of additional easing. Euro zone inflation was only 0.4 percent in October, marking 13 months of sub-1 percent price increases. If the ECB announces a bond-buying program in response to deflationary pressure, European exporters will benefit from a weaker euro. For ordinary consumers, low oil prices will provide a lesser boost than in the U.S., as European cars are much more fuel-efficient than American ones, says Michael O’Sullivan, Chief Investment Officer for Eastern Europe, the Middle East and Africa in Credit Suisse’s Private Banking & Wealth Management division.

The Oil Producers

The major question for oil markets right now is whether Saudi Arabia, the world’s swing producer, will cut production in order to boost global prices. Stuart says there are no signs that a cut is coming, such as a decrease in the number of rented crude oil tankers departing the Kingdom, but his current Brent crude forecast nevertheless builds in a reduction of 900,000 barrels per day before the end of the year. An announcement to that effect could come as soon as the Nov. 26 meeting of the Organization of the Petroleum Exporting Countries (OPEC). As Stuart and others have noted, the Kingdom is under domestic pressure to keep oil revenues high, given that the International Monetary Fund estimates that Saudi Arabia needs oil prices of at least $83.60 a barrel to balance its budget.

In Venezuela, oil sales provide both 47 percent of government revenues and the main source of foreign currency. The result: the country’s economy will suffer disproportionately from falling oil prices. By the same token, the sudden drop in crude prices has triggered a run on the Russian ruble, which has fallen 91 percent against the dollar since the beginning of June. The weak currency, in turn, is driving inflation higher and forcing Russia’s central bank to raise interest rates even as the domestic economy struggles. Credit Suisse expects the combined effect of international sanctions and energy prices to shrink domestic GDP 1.5 percent next year. In Malaysia, reduced revenues from exports will overwhelm government savings on fuel subsidies, Credit Suisse says, making spending cuts likely. The bank thus sees a downside risk to its 5 percent GDP growth forecast in 2015.

India

The Indian government subsidizes kerosene and LPG for cooking and heating. But Credit Suisse thinks that the country’s leadership will have to use any windfall from reduced subsidies to plug its budget gap, rather than to stimulate economic growth. That said, cheap oil could be a “game-changer” for Indian monetary policy. The Reserve Bank of India has raised interest rates three times since last September, most recently in January to 8 percent. At least in part due falling energy prices, though, inflation fell to an all-time low of 5.5 percent in October, nearly half of the 11.47 percent rate of November 2013. Since India recently deregulated the sale of diesel fuel, Credit Suisse expects lower inflation in wholesale and tradable goods, food, and freight. Starting in the second quarter of 2015, the RBI may finally be in a position to cut rates, rather than raise them.

Asia

In those economies that either don’t subsidize fuel or have relatively small subsidies — including, Korea, the Philippines, and Taiwan — inflation should drop significantly, ushering in more dovish monetary policy than would otherwise have been possible. Credit Suisse analysts now expect slower than expected interest rate hikes in the Philippines next year, and they think Korea and Thailand could enact further rate cuts. Lower fuel prices will also provide Korean consumers with an effective tax cut equivalent to 0.7 percent of nominal GDP.

Photo of a gas station in Thailand by LoveFreedom courtesy of Shutterstock.com

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