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The Oil price collapse – what it means for UK business and beyond

Weakening global demand and a glut of supply has seen Brent Crude prices fall below $80 per barrel this month, similarly US crude dipped to just $76 per barrel

Reacting to the news and the impending meeting of OPEC on 27th November, Commerzbank said:

“We believe that the downside risk to prices is still greater in the short term”

This observation was echoed by the US Energy Information Administration (EIA) part of the US Department of Energy who cautioned:

“Saudi Arabia’s role in the oil market going forward is highly uncertain. Saudi Arabia has stated that it would rather maintain its export market share than cut production to keep prices higher.

“In the past, Saudi Arabia often played the role of the swing producer, cutting its production to accommodate supply growth elsewhere or increasing its output level to make up for a supply shortfall.”

Saudi’s oil minister Ali al-Naimi provided no clues as to their long term intentions and the role they intend to play in the market when he said:

“We do not seek to politicise oil…for us, it’s a question of supply and demand, it’s purely business.

“We do not set the oil price. The market sets the prices”

The EIA however expects US crude to average $77.75 per barrel in 2015, a significant decrease on the previous forecast of $97.72, whilst similarly Brent crude was forecast to average $83.42 compared to $101.67.

Amplifying the impact the EIA has also reviewed its global forecast by 200,000 barrels per day (bpd) to average 92.5m bpd in 2015, with weaker global economic growth prospects expected to significantly curtail demand.

Meanwhile, in Europe, the International Energy Agency (IEA) said:

“While there has been some speculation that the high cost of unconventional oil production might set a new equilibrium for Brent prices in the $80 to $90 range, supply & demand balances suggest that the price rout has yet to run its course.

“It is increasingly clear that we have begun a new chapter in the history of the oil markets”

In what may prove a prescient analysis Chris Beauchamp, Market Analyst at IG predicted:

“Crude prices are enduring another hefty move lower, with Brent shifting below $80 for the first time since late 2010. With this key level out of the way a move towards $75 now looks likely as the hunt for a real floor in oil prices goes on.”

An even more strident view was offered by Julian Jessop, of Capital Economics, who underlined that:

“The slump in the price of Brent below $80 per barrel is consistent with our long-held view that the world will soon be awash with oil”

So with almost all analysts and commentators predicting fresh and prolonged oil price falls what are the prospects for the major oil producing nations, consumers and world economy?

Saudi Arabia

Saudi’s economy is oil, oil, oil, yet despite high public spending and largesse, and needing the oil price of at least $90 a barrel to balance the books, the prescience of storing cash reserves to ride out revenue shortfall looks a sensible play.

Indeed many are viewing the Saudis current price lowering as an intended position taking a short term pain of falling revenues against a long term strategy of ‘starving’ less prepared oil producers such as Russia, Iran and Libya who they confidently expect to exhaust cash reserves before they do themselves.

In addition the Saudis main target is understood to be US shale and its increasing influence on demand and global prices. Targeted price cuts to the US simply reinforce this view.


In contrast Russia, although carrying significant reserves of their own, are being hurt by both the falling price of oil and the western sanctions against their imperialistic ambitions in the region.

With oil and gas accounting for 70% of Russia’s annual budget the former USSR needs the oil price to be consistently above $100 a barrel in order to fund it.

Indeed with the fall of the rouble over recent weeks, the much vaunted foreign exchange reserves, that Putin and co expected would hold them firm have started to erode.

$400bn however is not enough to keep Putin calm with the admission that:

“We’re considering all the scenarios, including the so-called catastrophic fall of prices for energy resources, which is entirely possible, and we admit it”

A trying time for Russia indeed, as their energy dependent economy falters, sanctions grow, and their business pariah status begins to take hold leading to the prospect of a deeper recessionary climate in the already troubled region.

Economic impact

In contrast to the potential woes of Russia, the rest of the world could come out of the oil price collapse smiling. It is estimated that each drop of 10% in the oil price, and a sustained fall rather than peaks and troughs will lead to a 0.1% increase in GDP.

Given the falls seen so far that could represent 0.9% of global GDP already. As this is effectively a transaction from producing nations to consuming nations it is the oil hungry nations that would come our on top such as China, India and Europe.

Boom time is not imminent however with Richard Batley of Lombard Street Research explaining

“The maximum impact occurs around four quarters after the price reaches that level”

The other major economic indicator, inflation, will also see falls from a consistently low oil price. Indeed the falls to date are sufficient to deliver a headline inflation rate reduction of around 0.5%, an impact that would see a deflationary situation in the EU and a marginal 1% inflation rate in the UK. Whilst low inflation rates prompt spending the prospect of deflation is no economic panacea.

Nation states within the EU will be hoping for a sustained low oil price albeit with a clear floor to keep deflationary pressures away from the Eurozone.

Business impact

Similar to nations, it’s the big energy users amongst the business community who will see the most benefit most quickly. Particularly those in the transport, manufacturing and construction sectors where oil has a direct price influence could see significant benefits relatively quickly. As James Henderson, of Henderson Global Investors explains:

“Top-line growth is struggling so cheaper oil gives them immediate margin improvement”

Unfortunately however, for the average energy consuming business no such windfall cost reductions are likely. Unlike in continental Europe gas contracts are not directly linked to the oil price and as a result there is little and slow impact on the price businesses pay for gas or electricity from gas generation sources. Indeed with oil an increasingly marginalised direct fuel source in the UK only those users are likely to see resultant price falls.

Having said that however markets are driven by sentiment, and a benign coal price, and global geo-political issues not escalating traders could soften their forecasts and allow prices to be indirectly impacted by the oil story running in the background.

The cost of gas as well as oil is subdued ahead of Winter 2014 with a glut of LNG supply so whilst falls are being seen across commodities the drivers themselves are not necessarily directly linked. Of course oil producers who can also monetise LNG production can switch ‘horses’ and exploit different areas whilst economics allow.

The alternate view

Whilst we can be pretty sure of what is happening, the why is more challenging. We know that Saudi is the key swing producer in oil and the assumption has been that their desire to remove competition from Iranian, Libyan and US oil supplies by rendering them economic through below market pricing, there is another view.

Michael Reagan, the son of the late US President Ronald Reagan has an interesting theory:

“I suggest that President Obama might want to study how Ronald Reagan defeated the Soviet Union. He did it without firing a shot, as we know, but he had a super weapon – oil.

“Oil was the only thing the Soviets had in the 1980s that anyone in the rest of the world wanted to buy, besides ICBMs and H-bombs, and they weren’t for sale.

“Since selling oil was the source of the Kremlin’s wealth, my father got the Saudis to flood the market with cheap oil.

“Lower oil prices devalued the rouble, causing the USSR to go bankrupt, which led to perestroika and Mikhail Gorbachev and the collapse of the Soviet Empire.”

As we say, interesting.

However whatever the reasoning behind the Saudis pivotal moves, right now oil is as ever proving the saviour of some and the destroyer of others. The difference this time is the roles have been reversed, with consumers benefitting to the cost of producers.