Oil Prices Fall, and the Global Economy Wins

The Saudis are cutting production to try to slow falling prices
The refinery at Shaybah Oil Field in Saudi Arabia Photograph by George Steinmetz/Corbis

Oil is in the middle of one of its steepest selloffs since the financial crisis, with prices on the international market falling 18 percent since mid-June, to $94 a barrel on Sept. 30. There are two explanations—not enough demand or too much supply. Supporting the weak demand argument: a stagnant economy in Europe, slower growth in China, and flat gasoline consumption in the U.S. According to the International Energy Agency, in 2014 world demand for oil will grow only 1.5 percent.

But the bigger factor appears to be surging global oil production, which outpaced demand last year and is shaping up to do so again in 2014. To try to keep prices high, Saudi Arabia, the world’s biggest petroleum exporter, has reduced its oil production from 10 million barrels a day—a record high—in September 2013 to 9.6 million as of Sept. 30. That hasn’t done much to raise prices, mostly because other OPEC countries are pumping more crude as the Saudis try to slow down. Sharply higher production increases from Libya and Angola, along with surprisingly steady flows out of war-torn Iraq, have pushed OPEC’s total output to almost 31 million barrels a day, its highest level this year and 352,000 barrels a day higher than last September. Combined with the continued increase in U.S. oil production, the world has more than enough oil to satisfy current demand. “I would definitely give the edge to the supply story at the moment,” says John Kilduff, a partner at Again Capital, a hedge fund in New York that focuses on energy.

Although that might not be good news for oil producers, it’s great for consumers and the global economy. A report by Andrew Kenningham, senior global economist at Capital Economics, attempts to gauge the difficult-to-measure global lift from lower oil prices. “A $10 fall in the price of oil transfers the equivalent of 0.5 percent of world GDP from oil producers to oil consumers,” he writes. That in turn will have a knock-on effect on global consumption, because consumers tend to spend more of their income than businesses. Assuming consumers spend half their savings from cheaper oil, Kenningham continues, “a $10 fall in the oil price would boost global demand [for goods and services] by 0.2 to 0.3 percent.”

By lowering gasoline bills, cheaper oil prices could potentially increase purchasing power for U.S. consumers in time for the holiday sales season. “That money is going to be moving into cash registers this fall,” says David Rosenberg, chief economist at Canadian investment firm Gluskin Sheff. “Cheap gasoline acts like a tax cut that will flow through the U.S. economy in a big way. This couldn’t have come at a better time.”

Cheaper oil, though, means different things for different parts of the world. In Europe, where policymakers are struggling with deflation, lower oil prices will only make the European Central Bank’s challenge harder as it loosens monetary policy to try to raise consumer prices. Abundant oil also might not be good news for some big petro states. Kenningham says Russia and most of the Middle East can weather lower prices because they socked away enough oil revenue, but countries such as Brazil, Mexico, and Venezuela will be more negatively affected “primarily because they have not been saving much of their oil windfalls.”

American consumers shouldn’t consider their savings a windfall quite yet. For one, they’re driving fewer miles than they used to and doing so in more fuel-efficient vehicles, reducing the impact gas prices have on their overall spending. Through the end of September the average price for a gallon of regular gas in the U.S. was $3.51; that’s only 5¢ cheaper than during the same period in 2013. “When you think about the impact compared to last year, it’s a rounding error,” says Jacob Oubina, senior U.S. economist at RBC Capital Markets. “Gasoline will have to keep getting cheaper before you can start the conversation about this being a big positive for the U.S. consumer.”