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Impact of lower oil price
The oil price has dropped roughly 50% over the past six months and most analysts are now busy updating their macro and equity models with the new assumptions for the oil price, says Marcus Svedberg, chief economist at East Capital
Marcus Svedberg 26 Jan 2015
 
   

The oil price has dropped roughly 50% over the past six months and most analysts are now busy updating their macro and equity models with the new assumptions for the oil price.

 

There is still a lot of uncertainty as there are supply as well as demand factors - and perhaps some politics as well - behind the sharp correction. We believe the price will remain volatile in the coming months, possibly moving even lower from current levels, before recovering during the second half of the year. Speculating in what the average price will be for the year may not be very productive at this point but it should be clear that the price will be significantly lower than in the previous few years. The current consensus, which is similar to forward contracts, around US$60 per barrel for Brent seems a reasonable hypothesis at this point.

 

That would mean that the oil price will be roughly US$40 lower than in 2014 and US$50 lower than the previous three years when it was remarkably stable around US$110. The most obvious impact is that this is positive for oil importers and negative for oil exporters. And it is particularly positive for importers with large current account deficits and particularly negative for exporters with high fiscal break-even limits that do not have large financials buffers.

 

But the most interesting thing about the falling oil price is that it is exacerbating a number of underlying trends. In general terms, it is putting even more downside pressure on inflation. Consumer prices in most major economies started to decelerate in the second half of 2014 with the Eurozone even falling into deflation in December for the first time since the global financial crisis in 2009. This suggests that the ECB will be even more likely to embark on quantitative easing, possibly already at the end of the month, while delaying the US Fed's first rate hike even further. It is not only reinforcing the downward pressure on consumer prices lower, but also exacerbating the weak producer prices, especially in a number of large emerging economies.

 

Secondly, lower oil price also means that the global economic recovery will be even stronger. Lower oil price is a global stimulus that will be more important for economic growth than the various financial stimulus packages. The IMF argues that it is a "shot in the arm" that will add between 0.3% to 0.7% to global growth in 2015 and 2016 by boosting consumption and decreasing the cost of production. The gains are, on the one hand, unevenly distributed between importers and exporters, and, on the other hand, between importers. Economies with little or no oil production as well as those with high a degree of energy intensity stand to benefit the most. Most emerging markets are winners in this respect but India, Indonesia and Turkey are perhaps the most obvious winners. Russia, Nigeria and the large oil producers in the Gulf are the most obvious losers.

 

The oil price drop is making an already bad macro situation in Russia and a number of other energy exporters even worse while the opposite is true for Turkey and other large energy importers, especially in Asia. At US$60 oil, Russian growth may contract more than 4% while Turkish growth should be able to grow more than 4%. Similarly, inflation decelerated to 8.2% in December in Turkey, and should continue to fall in the coming months, while it accelerated to 11.6% in Russia.

 

It is, at this point, important to emphasize the weak correlation between short term macro and stock market developments. That Turkey is looking better than Russia from a macro perspective does not necessarily mean that the former market will outperform the latter. This is partly because some of this is already priced in as the Turkish stock market was up more than 30% in 2014 while the Russian was down more than 35% (both in euro terms). Also, it is tempting to look back to 2009 when the Russian economy contracted almost 8% and the stock market rallied over a 100%. Previous performance is certainly no indication of future performance but at least the oil price, which arguable is an important factor for the Russian market, looks set to repeat the 2008-2009 trend.

 

Marcus Svedberg is the chief economist at East Capital

 

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