The recent sharp drop oil prices represents a large transfer of wealth from producers of oil to consumers of oil — roughly $1.5 trillion, or 2% of world GDP.
There are two reasons to expect that such a transfer will have a net positive effect on the global economy. First, oil consumers have a much bigger weight in global GDP than oil producers. Second, if recent history is a guide, oil-importing countries tend to spend a larger share of their “windfall” than oil-exporting countries. Of course, some countries, such as Canada and the United States, are both producers and consumers of energy.
Who is helped and who is hurt?
Helped: $80 billion tax rebate equivalent for the United States.
A drop in the prices of oil and products derived from oil (gasoline, diesel, jet fuel, heating oil, etc.) increases the purchasing power of consumers and businesses. For example, the (roughly) 80 cent per gallon drop in the pump price of gasoline in the United States in recent months is the equivalent of $80 billion tax rebate.
It also has the added benefit of boosting consumer confidence. Businesses that use a lot of oil (such as agriculture and transportation) will also see a significant reduction in their costs. The positive impact of lower oil prices is the greatest in those countries (e.g., the United States) where both energy taxes and subsidies are low. Where fuel taxes are high (e.g., Europe) or where fuel subsidies are generous (numerous emerging markets), the impact of an oil-price drop on consumer and business incomes is proportionally smaller.
While steep declines in the price of oil and other commodities may exacerbate deflationary pressures in some economies, for example China, the Eurozone and Japan, it will also give many central banks more room to maneuver, allowing them to either keep policy very loose or to provide more stimulus.
Hurt: Producers of oil
Lower oil prices translate into lower revenues for oil companies and governments of oil-exporting countries. Iran, Russia, and Venezuela are particularly at risk. All three countries rely on high oil prices to balance their budgets. The so-called fiscal breakeven point for all three is much higher than current prices—well over $100.
Iran and Venezuela have low financial reserves and especially profligate budgets. In the case of Venezuela, the risks of a sovereign default have risen. Russia, on the other hand, has a little more room to maneuver, given its higher foreign-exchange reserves. Nevertheless, falling oil prices are only adding to the pain of sanctions and capital flight, as evidenced by the free-fall of the ruble in December.
Overview of impacts by key regions and economies
Predictably, different regions of the world will see differential effects from lower petroleum prices. The following are the increases/decreases in 2015 growth, assuming that the current level of prices ($60 to $70 for Dated Brent) is sustained through the year. These impacts are muddied by domestic developments in each economy (e.g. weakening domestic demand in China due to the ongoing property bust).
- North America. US real GDP growth will likely be boosted by 0.3 to 0.5 percentage points, with a sizable contribution from consumer spending. The impact will be smaller (0.2 to 0.3 percentage points) in Canada, given the bigger role played by energy. On the other hand, because Mexico relies on oil for one third of its government revenues, growth will likely be cut by 0.2 to 0.4 percentage points.
- Western Europe. The boost in European growth will be roughly in the same order of magnitude as the United States (up about 0.3 to 0.4 percentage point). Not all countries will benefit, however. Specifically, Norway, a major oil exporter, could see a drop in GDP growth of 0.2 to 0.4 percentage point
- Emerging Europe. Lower oil prices will help key Central European countries such as Poland and Turkey, adding 0.5 to 0.7 percentage point to GDP growth. On the other hand, it will hurt the major oil exporters of the region and will likely contribute to a deep recession in Russia.
- Asia. The net effect on Asia will be positive, but probably small. Both China and Japan could see a boost to their GDP growth rates of 0.2 to 0.3 percentage point. The impact on India and Indonesia (both net importers of oil) will be a little larger, at 0.4 to 0.5 point. The magnitude will depend on what actions, if any, the governments in these economies take on fuel subsidies.
- Central and South America. The impact of falling oil prices on the Latin American economies will be mixed. Net oil importers—such as Brazil, Argentina, Chile, and the Central American countries—could see a small boost to growth of 0.2 to 0.3 percentage points. At the other extreme, Venezuela’s economy will suffer a deep downturn.
- Middle East and Africa. Countries in the region hurt by lower oil prices include Kuwait, Iran, Libya, Saudi Arabia, UAE, Angola, and Nigeria. The hit to GDP growth could be as much as 1.0-1.5 percentage points. Countries benefiting from lower oil costs include Jordan, Lebanon, Morocco, Tunisia, South Africa, and Zambia.
Since the key beneficiaries of the recent oil price declines are the biggest economies in the world—the United States, the European Union, China, and Japan)—the net effect on global growth will likely be in the positive and in the range of 0.3-0.5 percentage points.
Author: Dr. Nariman Behravesh is the Chief Global Economist at IHS.
Image: A worker fills the tank of a car at a petrol station in Cairo, March 12, 2013. REUTERS/Mohamed Abd El Ghany.