Are Lower Oil Prices Here To Stay?
While oil prices have seen their third largest decline since World War Two, and one of the most dramatic ones in recent history, other commodities have also been gradually declining in price in recent months. Most experts foresee that this weakness in commodity prices will continue throughout 2015 before beginning a modest turnaround in 2016.
According to the World Bank’s latest Commodity Markets Outlook, released on January 22, 2015, this year may well see a rare occurrence for world commodity markets – a decline in all nine key commodity price indices.
Oil prices dropped 55% in seven months, from a high of $108 per barrel in mid-June 2014 to $47 in January 2015. The previous record declines in oil prices happened in 1985/86 (a 7-month decline of 67%) and in 2008 (a 75% drop).
A confluence of events and conditions has contributed to the dramatic drop in oil prices in the second half of 2014. These include: growth in unconventional oil production, decline in demand, slowdown of emerging markets economies, appreciation of the U.S. dollar, declining geopolitical risks, and a decision by the Organization of the Petroleum Exporting Countries (OPEC) to maintain market share rather than maintain higher oil prices.
According to a press release by the World Bank on January 22, 2015, “Global supply and demand conditions have conspired to generate lower price expectations for all nine of the World Bank’s commodity price indices – an extremely rare occurrence,” said Ayhan Kose, Director of the World Bank’s Development Prospects Group.
The proximate causes of the steep drop in oil prices, however, have two key similarities with one previous episode.
“Both the current oil price collapse and the one experienced in 1985/86 followed an increase in oil production from unconventional sources and OPEC’s abandonment of price targeting,” said John Baffes, Senior Economist in the World Bank’s Development Prospects Group.
The current forecast sees oil prices averaging $53 per barrel in 2015, 45% lower than in 2014. The weakness in oil prices is likely to impact trends in other commodity prices – in particular, those of natural gas, fertilizers, and food commodities.
By 2016, a recovery in the prices of some commodities is likely to be underway, although the increases will be small compared to the depths already reached.
Source: The World Bank – January 22, 2015
What are the Implications of Lower Oil Prices?
Lower oil prices can benefit the world economy due to increased money in the pockets of consumers and businesses.
According to Eric Lascelles, chief economist at RBC Global Management, in an “Update on oil” published in December 2014, “…the combination of lower oil, lower yields and weaker exchange rates should provide a boost of between 20-70 basis points to most major economies over the next year. For the U.S. economy, the impact is not purely good as shale producers are hurt by the price action. However, overall it is still a net positive for the U.S. economy.”
With regards to the Canadian economy, while Alberta and Newfoundland will be hurt by lower oil prices, the effects of the blow to the economies of the Western provinces will be buffered to a large extent by the weak Canadian dollar.
For the rest of Canada, lower oil prices will have a positive impact. A lower Canadian dollar is good for our exporting and manufacturing sectors and will boost Ontario’s auto industry. A weak currency and lower oil prices will also increase demand from the U.S. for Canadian goods and services.
The government will certainly suffer as a result of lower oil prices and balancing the federal budget will be challenging, with expected surpluses likely vanishing.
While low oil prices stoke fears of deflation, especially in Europe, where deflation is already a major concern, the boost that low oil prices can give to the world economy can counter the deflationary effects to a large extent. It can also compel central banks in Europe to start quantitative easing which can be positive for the stock market.
Tina Tehranchian is a Senior Financial Planner with Assante Capital Management Ltd. Please visit www.tinatehranchian.com or contact her at (905) 707-5220 for individual financial advice based on your personal circumstances before acting on any of the information above.