Capital Economics: What if oil prices fall to $40?

Baku, Azerbaijan, Dec. 19

By Aygun Badalova - Trend:

The slump in oil prices to below $60 per barrel should be a clear net gain for the world economy, analyst of British economic research and consulting company Capital Economics said in a report obtained by Trend.

"Indeed, the potential boost to global demand is one important reason to expect prices to level out soon. Nonetheless, further falls - say to $40 - could see the negatives start to outweigh the positives," according to the company's analyst Julian Jessop.

The wider consequences would depend in part on why oil prices fall so far, according to the analyst.

"In the last few days there have been renewed fears that the continued weakness in oil prices is an early signal of a sharp slowdown in the global economy. In these circumstances, nervous consumers might be more likely to save their gains from lower energy costs rather than spend them on other goods and services. The risks of a damaging period of deflation in economies which are already fragile would also be greater," analyst said.

However, Jessop said, the falls to date have been driven mainly by supply-side developments in the oil market, which are far more likely to be benign. He also added that oil had been propped up by fears over Middle East supply which have now evaporated.

Each $10 per barrel fall in the price of oil, according to the analyst, represents a transfer of annual income of around $330 billion, or 0.4 percent of world GDP, from oil producers to oil consumers.

"Starting from the summer level of around $110 per barrel (for Brent), the fall to $60 is worth some $1,65 billion, or 2.0 percent of world GDP. A further decline to $40 would lift these figures to $2,31 billion and 2.8% respectively. The net boost to global demand will be smaller than these numbers, as oil consumers are spenders too, but it should still be substantially positive," analyst said.

One risk is that lower oil prices could tip heavily-indebted economies with already poor growth prospects over the edge, according to the analyst.

The disinflationary impact of a further drop to $40, he believes, would not be that much greater than that from the slump which has already taken place.

"However, we already think it likely that euro-zone inflation will turn negative in the coming months, and $40 oil would pretty much guarantee that result," analyst said in a report.

The second concern, according to the analyst, is that the losers from lower oil prices may be hit so hard that the fallout from their problems offsets the more diffuse benefits to the winners, even if the latter group is much larger.

"This fallout might be economic, financial, or even geopolitical," analyst said, adding that these risks are likely to build if oil prices fall further, and
could weigh disproportionately on sentiment both in the financial markets and elsewhere.
During Thursday's electronic trading on the New York Mercantile Exchange the West Texas Intermediate (WTI) for January delivery decreased by $2.36 to $54.11 a barrel.

February Brent, which is the benchmark price for products in Europe and Asia, decreased by $1.91 to $59.27 a barrel on the London-based ICE Futures Europe exchange.

Aygun Badalova is Trend Agency's staff journalist, follow her on Twitter: @AygunBadalova

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