Back in September last year, the Wall Street Journal wrote an article about how low oil prices could lead to a global recession. An article by the Guardian last Friday repeated the sentiment with a suggestion that low oil prices could hurt the stock market.
Look out, Chicken Little, the sky is falling!
The doom and gloom argument appears to be based on two factors:
- Falling oil prices will hurt oil producers like Exxon and Chevron. Since these firms are large, falling profits will lead to lower share prices which in turn will pull down the market index and lead to a drop in the overall market. This would bad for shareholders;
- Secondly, the falling oil price will make it more difficult for oil companies to repay outstanding debts. When oil prices were high many Wall Street banks lent money to finance new drilling expeditions, and Dealogic estimates that the oil and gas industry has roughly $500 billion in outstanding debt. Increased levels of distressed debts could lead to stress in the banking sector.
Oil producers and the banks who backed their optimistic projects during the boom years will stand to lose in the new reality of low oil prices.
Luckily though the economy is composed of more than just banks and oil producers.
Richard Branson, the billionaire entrepreneur and philanthropist, provided some sound wisdom at Davos recently when he said that “oil prices are good for the consumer, they are good for most businesses. They are very good for the airline businesses. And obviously if you are an oil company they are not so good for you. But I think what the market has missed is that with oil below $30 a barrel and likely to stay there for a long time, that there is no need to try to make up a recession. This is going to be the greatest boost to the economy that you can imagine.”
In support of Branson’s view, The Economist reported on Saturday January 22nd that “the economies that have enjoyed the strongest GDP growth in the past year have .. been oil importers: India, Pakistan and countries in east Africa.” Similarly, in the IMF’s latest forecast, published on Tuesday January 19th, the economies that were spared a GDP growth downgrade — China, India, Germany, Britain, Spain and Italy — were all net oil importers.
While it is true that a slump in oil prices will produce winners and losers, and there are likely to be stormy waters ahead for countries like Brazil, Saudi Arabia, Russia and Nigeria, the good news is that the sky is not falling.