The economic effects of a falling oil price

Brent crude oil was trading US$75.95 a barrel on the 30 October 2018 but within a month it had fallen to under US$60. The political tensions between the United States, Iran, and Russia threatened the supply of oil, causing a spike in the price. However, when the US issued sanction waivers for eight countries importing oil then the market turned bearish on the commodity on fears of oversupply. A drop the oil price can be felt by motorist by a reduction in petrol prices but what are the global implications of a decline in oil prices?

Consumers: Lower oil prices means consumers have more discretionary cash to spend money on products. This could help grow the economy. This is because if oil prices are low, then households will benefit from lower fuel cost. It will also lower energy bills leaving more money in the household budget.

Businesses: Businesses can benefit from lower oil prices as this can mean lower transportation, manufacturing and energy cost. These lower costs can therefore increase their net profits.

Airline Companies and Travellers: Lower oil prices can mean a decrease in fuel costs and airlines can therefore sell seats for cheaper prices. The popularity of cheaper airline tickets can boost sales and increase earnings for airline companies. Travellers will also benefit from oil prices with cheaper airline tickets.

Decreases in energy sector profits:  Lowering oil prices can affect the earnings of companies in the energy sectors as they receive less for their oil. This can cause stock prices to drop and other knock on affects from depressed earnings.

Increases in Redundancies:  Lower oil prices can impact jobs related to the oil industry. If earnings are continually low then companies may need to reduce costs which may lead to redundancies. Exploration and production of oil sources has previously generated jobs in different fields such engineers, oil rigger and truck drivers. These jobs will be at risk with a lower oil price.

Decreases in Demand for Housing:  The oil boom helped create demand for housing as homes were needed for workers within the oil and gas industry. If the oil prices deceases, companies will need less employees and these oil workers won’t need housing near the oil projects. This will cause housing demand in these areas to decline.

Decreases in discretionary spending: If workers in the oil sector lose their jobs, then business which were serving these workers such as restaurants or hotel may also suffer if the oil sector collapses.

Bad Debts: These oil and energy companies may have debts they may struggle to pay which then negatively impacts creditors including banks.

Less Investment for Future Projects: When oil prices are high, oil and gas companies invest heavily in exploration and production. However lower prices mean lower profit margins which can mean less money for future investments or perhaps cutting back in current projects.  A reduction in investment in exploration and production will have long term consequences for consumers. If oil and gas companies cannot find new sources, it could limit supply and make oil expensive.

Emerging Markets: Countries such as Venezuela, Colombia, Mexico and Russia will be greatly affected if the oil price is low. These emerging markets rely heavily on the export of oil as it takes up a large part of their GDP. Developed countries such as the US will be less affected by the fall of oil prices as GDP is generated from different industries.

Economy: Declining oil prices may mean the economy is not doing well as this may indicate the global economy is not growing fast enough to consume the increase in oil supply.

Lauren Hua is a private client adviser at Fairmont Equities.

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