Are falling oil prices a good or bad thing? The Saudi oil price war is raising those questions as they cut the selling price to Asia and say they think oil will stabilize at $60 a barrel, which may become a self-fulfilling prophecy.
While the European Central Bank and its Chief Mario Draghi will try to signal its willingness to take extraordinary steps to ensure price stability, the drop in the price of oil may prove to be a mixed blessing. On one hand the energy hungry Eurozone will see the benefit of low oil prices, yet at the same time it may feed into a deflationary mindset that seems to be plaguing the Eurozone. While Mr. Draghi may try to harp on the benefits of the falling price of oil like most central bankers, a falling price for oil is going to make it harder to stabilize the market.
The Euro currency hit a 2-year low as the market is convinced that Draghi will lay out the plan for QE and that of course will put further downward pressure on the price of oil as it will make the U.S. dollar soar. Yet knowing Draghi he may use the falling price of oil as further evidence that the ECB needs to act to try to shock the economy out of its disinflationary malaise. I wonder if the Germans are listening.
Yet falling oil prices are already starting to have some negative impact on the economy. We have already talked about a report that showed a drop of almost 40% in new well permits issued across the United States in November. The Fed minutes released yesterday also showed that there was concern growing in the oil patch. MarketWatch reported that “lower oil prices are raising alarms outside the domestic energy sector." They say a collection of anecdotes about the economy found growing concern among chemical companies, mining equipment and banks. While drilling remained high, the energy sector was clearly concerned.
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“Firms located in the Gulf of Mexico were re-evaluating their operations" and in Dallas, lower prices “weighed on the outlook for drilling activity.”
On top of that, they report that the demand for legal services from oil and gas companies has slowed due to the uncertainty. Banks in Texas said they were braced for a possible slowdown in business. Even the Fed Governor Stan Fischer wondered out loud whether low oil prices are "a phenomenon that’s making everybody better off," is actually the right way to look at this.
In Norway they are reducing investment in the oil sector by 14% next year.
So are falling oil prices a good or bad thing? My take is simple. Falling oil prices are a good thing as long as they are going down for the right reasons. Oil prices that were falling before the Saudi Arabia “price war” were a good thing. It was reflecting growing U.S. production and slowing demand and we saw an orderly decent in prices. Yet when you have a cartel openly declare a price war it causes panic and does not allow for consumers and producers to adjust normally. When cartels move to actively manipulate prices to try to force competitors out of business and dump oil into an oversupplied market it causes undue strain and a shock to the economic system.
Yes you can have negative effects from price shocks when the markets go up, but you can also have them when prices go down. If the market was allowed to do its job, while there would be winners and losers, it would happen in an orderly fashion. When you try to manipulate and create a price shock that is when you do real damage to the economy.
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