5 Things You Need to Know about Low Oil Prices

February 25, 2015 Topic: Economics Blog Brand: The Buzz

5 Things You Need to Know about Low Oil Prices

What is the fallout from the oil market crash?

The Council on Foreign Relations hosted a symposium yesterday on the causes and consequences of the oil price crash. Our three panels tackled the reasons for the crash and the future of oil prices; the economic fallout from the crash in the United States and around the world; and the geopolitical consequences of the oil price crash, both to date and going forward. (These links will take you to video of each session.) I trust that everyone took distinct conclusions away from the day. Here are five things I learned or hadn’t properly appreciated before:

Don’t believe what financial markets tell you about long-run oil prices.

Futures markets are good at predicting near-term spot oil prices. They’re even good at telling you what smart people think oil prices will be in a few months or a year. But when it comes to their predictions for oil prices five years from now? Forget about it. Markets for long-dated futures – say, for February 2019, where Brent crude last settled at $76 a barrel – are idiosyncratic and reflect the needs of a small number of players. Better, then, to rely on fundamental analysis. Unfortunately – as Citi’s Ed Morse, CIBC’s Catherine Spector, and the EIA’s Howard Gruenspecht all confirmed on our first panel – there’s little agreement on what those are. Still, if you’re uncertain, at least you won’t be wrong.

Consumer spending hasn’t yet responded to the oil price drop.

The oil price drop is supposed to act like a big tax cut – with all the stimulus that entails. As Mark Zandi of Moody’s Analytics noted on our second panel, a one dollar drop in the price of a gallon of gas should translate into a thousand dollars in annual household savings, which in turn should boost consumer spending, turbocharging the economy. Yet, as both he and Harvard’s Jim Stock observed, while we’ve seen some increased saving, we haven’t seen the expected boost in consumer spending yet. Part of the explanation might be that people wait a few months for savings to pile up before going out and spending. Neither Zandi nor Stock was particularly nervous yet – but Zandi warned that if consumer spending didn’t pick up soon, he’d start to get more anxious.

Falling oil prices have been a big help to emerging market economic policymakers. Emerging market oil importers obviously benefit from falling import costs. And I’ve written before that falling oil prices have allowed some emerging market policymakers to cut fuel subsidies. Charles Collyns of the Institute for International Finance (IIF) pointed out a third big dividend during our second panel: falling oil prices have eased inflation pressures and thus allowed emerging market central banks to cut rates and juice their economies. It’s easy to overlook this when you’re focused on the big developed economies; Europe and Japan are worried about deflation, not inflation, and the United States doesn’t have room to cut rates (though it can delay raising them). But when you’re more like India – with an inflation rate that hit eight percent in July of last year but now stands closer to five – this matters a lot.

Watch out for geopolitical fallout in the big oil exporters’ backyards.

As oil prices have plummeted, all eyes have been on the Russia-Ukraine conflict and on the Iranian nuclear negotiations, as observers have looked for signs that Moscow or Tehran might change tack. On our third panel, Georgetown’s Angela Stent and former U.S. ambassador Michael Gfoeller reported little change on either front, and warned not to expect much. But both of them – along with former State Department energy envoy David Goldwyn in his remarks on Venezuela – told people to look in the three big oil exporters’ backyards. As Russia faces budget and economic challenges, there will be economic and political spillovers in Central Asia; as Iranian revenues slide, Iran’s ability to support Hezbollah and other Shiite allies will decline; and as Venezuela tumbles, its ability to support others in the region through Petrocaribe will weaken, a dynamic that some have already argued played a role in U.S. rapprochement with Cuba.

Even the good geopolitical news often comes with a downside.

It might look like Egypt and Jordan – both energy importers – might benefit from falling oil prices. But, as Michael Gfoeller pointed out, both also receive support from a now-less-flush Saudi Arabia. It might also seem that climate change efforts could get a boost due to falling natural gas prices in Asia and Europe (gas and oil prices there are linked to varying degrees) – but, as David Goldwyn warned, the politics of falling oil prices could actually sap some of the sense of urgency from climate discussions. And as Angela Stent observed, economic turmoil for U.S. adversaries doesn’t necessarily lead to political change – something she noted for Russia but that applies more broadly.

This only skims the surface of what I took from the panels – and I’m sure others gleaned different things. You can watch all the three panels (priceseconomicsgeopolitics) at CFR.org, and add your own takeaways in the comments.

Michael A. Levi is the David M. Rubenstein Senior Fellow for Energy and the Environment at the Council on Foreign Relations. This piece originally appeared on CFR’s Energy, Security, and Climate blog.

Image: Flickr/miracc