The economics of falling oil prices

TORONTO—Oil prices have fallen sharply in dollar terms from their June 2014 peak.

A lack of clear guidance about the willingness of the Organization of the Petroleum Exporting Countries (OPEC) to curb supply has added to a more sober outlook for global growth. But while oil prices are moving significantly, so are currencies. In local currency terms, the U.S., U.K. and India have seen the largest declines.

Falling oil prices will push down inflation which, for the West’s key commodity importers, may improve real wages. In normal times this would be “good disinflation.” However, inflation rates are currently so low that expectations could become dislodged: policymakers may prefer to maintain a looser monetary stance.

If oil prices are falling because of weaker global growth, this is hardly a good story for any country. Weaker demand could offset the benefit of lower costs.

However, importers are relative winners and exporters are losers. There are thus huge distributional consequences for global growth.

Emerging markets are both the largest beneficiaries and the largest losers.

India and Turkey are the largest emerging-market significant oil importers, while the Gulf states and Russia are the largest exporters. In the developed world, Spain and Japan benefit most from falling oil prices, even if it doesn’t offset other internal problems.

Middle East oil producers have used their oil-income windfall to boost public spending almost fourfold since 2003. With the Gulf tax-take typically less than two per cent of GDP, it is clearly not in OPEC’s interest to see prices fall. Even if prices stabilize, all but the very richest Middle East producers would start to register fiscal and, in some cases, current-account deficits.

In Saudi Arabia, for example, a US$20 a barrel oil price would have balanced the budget in 2003 but in 2015 we estimate it will require US$90 to cover increased spending. Bahrain’s and Iran’s breakeven oil price is likely to be above US$130 a barrel next year. Indeed, below US$90, only the UAE, Kuwait and Qatar would have budget surpluses in 2015.

With no other ready sources of income, and spending commitments difficult to reshape, the deterioration in fiscal performance that comes with sustained declines in oil prices is sharp. At US$70, for example, we estimate that Saudi Arabia’s budget shortfall would approach 10 per cent of GDP next year; at US$50, the deficit could exceed 15 per cent.

However, the regional producers, which together account for more than 30 per cent of global oil supply and, critically, 80 per cent of OPEC output, have generated such large surpluses over the past decade that they have the balance-sheet strength to deal with lower-than-expected oil income.

Since 2003, for example, Saudi Arabia has generated cumulative budget and current-account surpluses of USD600 billion and USD1,000 billion, allowing it to build up currency reserves equivalent to 90 per cent of GDP—three full years of public spending—and reduce debt from 100 per cent of GDP to less than 5 per cent.

So despite the current price weakness, the wealth that Middle East states have accumulated affords them considerable room to manoeuvre.