Show Hide image Economy 29 January 2015 Your petrol bill may fall, but is cheap oil all good news? The falling oil price may sound like a positive thing, but it follows a series of worrying events in global economics. Print HTML he past few months have brought a spree of frightening developments in the global economy. There’s been the slow crash of the Chinese property market, the eurozone’s slide into deflation and the relentless strengthening of the US dollar, to start us off. But there is no doubt what the biggest and most baffling development of all has been: the collapse in the price of oil, from more than $100 per barrel as recently as last September to less than $50 per barrel today. Oil, it goes without saying, is the single most important commodity there is. Quite literally, it greases the wheels of the global economy. It is a commodity that is unequally distributed: a few countries have a lot of it – the Saudi Arabias, Russias and Venezuelas of the world – while most countries have none. Some have about enough for their needs (notably, these days, the US) but most have to import almost everything. It’s no surprise that the price of oil is one of the critical drivers of both the rate of global growth and the way it is shared between nations. So, why has the oil price collapsed and what does it mean for the world economy? The answer to the first question is easy: nobody really knows. Since the 2008 financial crisis, people have become used to the idea that economists are useless at predictions. The number of analysts who warned that the growth of credit in the mid-2000s was not sustainable can be counted on two hands. The number that got the timing right can be counted on one. But the number of analysts who predicted the collapse in oil is even smaller. As far as I can tell, it was approximately zero. Of course, after the event, all kinds of plausible explanations have been on offer. The simplest is that this kind of price action is typical of any commodity investment cycle. The capital equipment required to extract oil on a large scale is vast and costly and it takes years to install. When prices are high, as they were until recently, governments and companies compete to plough billions of dollars into rigs and pipes. The result is a glut of investment, followed by a glut of supply when the new kit comes on stream. And so the price collapses, leading to frantic cost-cutting and a dearth of new investment – sowing the seeds for the supply shortage that will kick-start the next cycle. It’s a neat enough theory in general, and yet its very neatness raises the question of why no one saw the latest price crash coming. Few of the relevant investment plans were secret, after all, and there is a huge and profitable industry devoted to speculation on the price of oil – with every incentive to find them out. Naturally, there are other explanations: conspiracy theories about the Saudis and Americans conniving to hurt the Russians, or the Saudis going rogue in order to hurt the Iranians – but the speed of the collapse suggests it may have as much to do with a sudden drop in demand as a sudden glut of supply. What will the collapsed price mean for the global economy? For many, the answer is that oil producers will suffer nasty recessions – but their suffering will be far outweighed by the boost to growth in oil-consuming countries. If, however, the collapsing price reflects weak demand from the eurozone, China and the rest of the emerging markets, the result may not be so palatable. Certain market prices have an uncanny knack for foretelling economic weakness in the short term. For instance, is it a coincidence that the price of industrial metals such as copper – “Dr Copper”, as it is known on the financial markets, for its supposedly prodigious analytical powers – is also on the slide? Even more ominous is that the oil price drop has been accompanied by a steep decline in the interest rates that the world’s investors demand in order to lend to governments. When the UK government can borrow for five years at 1 per cent and Germany at less than zero (you read that right: investors are currently paying the German government for the privilege of lending to it), it does not suggest great confidence in the future of the economy. At a conference a few years ago, someone in the audience asked me what would happen when the Bank of England eventually put interest rates up again. Like any economist, I gave a long, rambling and non-committal answer. When I had finished, the excellent compère turned to the crowd and said: “Let me put that a bit more simply: it means your mortgage will get more expensive.” I know how he would summarise the effect of the current collapse: “It means your petrol bill is going to get cheaper.” Unfortunately, it may mean a lot more than that. › Late at night, in my dressing gown, I search the fridge for a piece of cheese and contemplate my fate Macroeconomist, bond trader and author of Money Subscribe This article first appeared in the 23 January 2015 issue of the New Statesman, Christianity in the Middle East More Related articles How two Canadians helped me get America into perspective Hannan Fodder: This week, Daniel Hannan gets his excuses in early Europe’s last Blairite: Can Manuel Valls win the French presidency?