Suddenly the world is awash with oil. A surprise surge in production and weaker than expected global demand for crude have sent oil reserves soaring and prices tumbling.
The 40 per cent drop in the oil price to around $60 a barrel since June is by far the biggest shock for the global economy this year. Similar episodes in the past tell us the consequences are likely to be both profound and long lasting. Normally, economists would add “positive” to this list, but doubts are surfacing as never before.
The scale of the current oil shock is difficult to exaggerate. While financial markets and commentators were obsessed by rising geopolitical tensions and the latest twists in central banks’ policies in the US, Europe and Japan, even larger forces in oil markets went largely unnoticed. As late as October, a “key concern” of the International Monetary Fund was the risk of an oil price spike caused by geopolitical tensions. Instead, rising production and weaker demand growth have left suppliers competing to find willing customers.
Rather than geopolitical tensions in Ukraine and Iraq causing an oil shortage and price spike, as foreseen in the IMF scenario, the causality is flowing from economics to politics. The plunge in oil prices now threatens Russia’s living standards and public finances to the point where it will start 2015 as a devalued and belligerent nation with nuclear weapons. In the Middle East, the funds to finance vicious conflicts in Iraq and Syria face greater pressures, which promise to stretch all sides. And the US is less likely to want to play global policeman now that it can satisfy almost 90 per cent of its energy needs from domestic sources, up from 70 per cent as recently as 2005.
In normal times, the broad effects of the oil price drop on the global economy are well known. It should act as an international stimulus that will nevertheless redistribute heavily from oil producing countries to consumers and the longer the new prices endure, the more profound will be the effects on the structure of industries across the world.
But this time, economists are actively debating whether the world has changed and other moving parts — such as falling inflation levels and the strong dollar — will throw sand into the works of the usual economic relationships.
But when oil prices fall, there is no iron law that enhances global economic growth. The main effect is a huge redistribution from oil producers, who receive less for the effort of extracting the black gold, to consumers who benefit from cheaper transportation and energy, enabling them to spend more money on other goods and services or to save their windfall.