Falling oil prices much needed good news for global economy
As the world obsesses over every twist in the Eurozone drama, the drop in oil prices is very good news in what could be described as a depressing period.
While we've all been obsessing over every twist and turn in the Eurozone saga, something extraordinary has happened to the most important number in the world – the oil price.
In a little over three months, the cost of a barrel of crude oil has fallen from a high of US$128 to just $90 (AUD$127 to $89).
For a world running short of good news, this is a spectacularly helpful development. There are two short-term reasons for this collapse in the oil price.
The first is the deteriorating health of the global economy and, in particular, the coordinated nature of the downturn in demand. Slowing growth in the US, China and Europe means each leg of the economic stool is now wobbly.
The second near-term reason for the rapid fall in the oil price – its first move down to this level in 18 months – is the recent rebuilding of global stockpiles, largely as a result of Saudi Arabia pumping crude at a 30-year peak.
This is in line with Riyadh's stated desire earlier in the year to drive the cost of oil below $100 a barrel. As it tends to, the price has shot past target.
These cyclical reasons for a decline in the oil price go some way towards explaining why it has tumbled, but they are not the whole story and are arguably less interesting than the longer-term case that is now being made for a permanently lower cost of crude.
There are a couple of strands to the argument, which turns on its head the popular wisdom of recent years that energy would become ever more expensive as a result of the rising cost of extraction, the depletion of reserves, and accelerating demand – especially from emerging markets and revenue-hungry oil producers doing all they can to keep the price high.
The first of these longer-term reasons is that the supply shortages that drove the oil price higher from about 10 years ago have finally been reversed as a natural consequence of an escalation in exploration spending.
There has been a surge of discoveries that is now being converted into new production, in particular in North America where the US has gone in just four years from being the world's largest importer of gas to being entirely self-sufficient.
The trigger for this rise in investment was the rapid rise in the oil price from 2002 onwards, in turn, triggered by the failure of four of the Organisation of the Petroleum Exporting Countries’ (OPEC’s) main oil producers – Iran, Iraq, Venezuela and Nigeria – to deliver expected increases in capacity.
Suddenly, oil exploration made sense again and we are now starting to see the benefit in terms of abundant supply.
Citigroup believes this shift in the supply/demand balance will lead to a long-term sustainable oil price of between $80 and $90 a barrel.
The second longer-term reason for the oil price to move permanently lower is the more interesting because it represents a game-changer for the global economy.
It is the potential for the US to become energy independent as a result of technological advances in the exploitation of shale oil and gas, vast reserves of hydrocarbons that are trapped in sedimentary rock where, until very recently, they defied economically viable extraction.
Since 2007, when technology constraints were overcome, the US has been extracting so much shale gas that it now accounts for 30 per cent of total US gas consumption.
Thanks to this new source of supply, the price of gas has fallen sharply in the US and, with the techniques starting to be used for oil production too, the prospect of cheap energy is once more realistic.
The benefits are obvious, from rising disposable incomes and industrial competitiveness to increasing investment and lower inflation – all good for economic and corporate growth.
For investors, there are plenty of ways to play the oil story.
These include oil service companies supplying the technology that makes shale viable as well as the energy companies and other big manufacturers that will benefit from lower input costs.
Markets won't rally until the Eurozone drama is closer to a conclusion, but lift your eyes from it and you'll see some good news.
Tom Stevenson is the investment director at Fidelity Worldwide Investment.
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