As we start reading this article, oil prices might have reached another bottom. On one side, lower oil prices are helping economies of big oil importers like India, China, and Europe; on the other, the economic status of several oil producing nations like Nigeria, Algeria, Venezuela are in shambles. Lower price of any commodity is a boon for world economic growth. Is this true for oil?
Oil producing nations can be broadly classified under 3 categories –
•Multi——taskers: Diversified oil producing nations who are major oil producers but their economy is well diversified and hence, don’t depend on oil anymore (US, Canada etc)
•Aspirers: Oil producing nations who have the lowest cost of operations, and have accumulated lots of reserves (strong surplus) and can withstand price shocks for the next few years (Saudi Arabia, Kuwait, UAE etc). With the surplus funds, they are investing towards diversifying the economy.
•Strivers: Oil producing nations who are not very efficient and need oil prices above $ 80 to support their welfare (Algeria, Venezuela, Libya etc)
Oil prices averaged around $95 during 2005 —— 2015. (2005——2010: $80, 2010——2015: $110). During this period, striving nations like Algeria focused on building agro based economy as a part of diversifying beyond oil based economy. This was a golden period for ‘Strivers’ who were progressing towards ‘Aspirers’. Many of the African nations showed good GDP growth. At the same time, higher oil prices lead to severe financial stress in oil importing nations like India.
(Optimal price for oil where both OPEC and others reach reasonable profitability is around $80, Source: Economist article Jan 22 2016 ” Adjusting taps on oil prices” , Rystad Energy: Quandl )
Scenario 1 —— “Global Imbalance”: Long term oil price less than $80
Most of the ‘Aspirers’ who had strong surplus (Saudi Arabia $700bn, 2015) will start facing fund crunch for development. Badly governed ‘Aspirers’ will move down towards ‘Strivers’ and ‘Strivers’ will enter a period of uncertainty, poverty, emergence of terrorism, dictatorship etc. Most of African nation’s GDP growth will decelerate. Low oil prices can be a stimulant to GDP growth of several oil dependent developing nations like India, China.
Scenario 2 —— ” Sustained Slow Growth” : Long term oil price above $80
In this scenario, most of OPEC nations : Saudi Arabia, Iran, Kuwait, UAE, Qatar will be highly profitable and Iraq, Venezuela, Nigeria, Angola, Libya achieve reasonable profitability. Others like Russia, Algeria, Azerbaijan, Kazakhstan will also achieve reasonable profitability. In this scenario, highly profitable and well governed ‘Aspirers’ will progress well towards ‘Multi——taskers’ and many ‘Strivers’ with better governance will progress towards ‘Aspirers’. Oil dependent nation’s GDP growth will be impacted due to higher oil prices.
Under scenario 1, polarization will emerge. Diversified developing countries like India, Indonesia, China will progress well. Both “Aspirers’ and ‘Strivers’ will struggle to maintain status quo. Strivers struggling under bad economic conditions will experience massive poverty, civil war, mass immigration, and infiltration of terrorist groups. Developed nations will face moral issues of immigration as well as threats of terrorism. G7, G20 groups along with UN will channel funds to support poor nations and each nation will allocate funds towards security. High cost of security will become a growth barrier for developing nations. More investments will be allocated to sustenance of poor nations and to maintain domestic security, resulting in inefficient global growth.
Under scenario 2, wealth will be more spread out across all nations . Developing nation’s growth will slow down by higher input prices. Oil producing nations will flourish. ‘Strivers’ with better economic policies will progress towards ‘Aspirers’, highly profitable ‘Aspirers’ will invest in diversification and emerge as successful ‘Multi——taskers’. Other ‘Aspirers’ will accumulate surplus funds and will start investing towards diversification. Africa will deliver to its potential and human race will progress towards poverty eradication. Russia will reemerge as a powerful nation.
The oil price depends on demand supply conditions, and dependence of oil as energy source. Due to lower oil prices, lower investments are being made. As demand picks up, prices will moderate leading to higher investments. As auto industry develops electric vehicles, oil dependency might reduce thereby reducing oil demand. (though impacts will be minimal during medium term)
To conclude, lower commodity price is always desirable. However, lower oil prices might lead to more imbalance and instability. Hence, is lower oil price is bane to the world economy?
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