The price of oil has sunk almost 50% since June with West Texas Intermediate crude slipping below $60 a barrel last week and Brent falling below the same level on Tuesday. “Yippee!” I hear you say, “cheap gas and a drop in inflation!” Well, yes in terms of a boost to consumers, and indeed a boost to global GDP, lower oil prices are a good thing and make most of us feel better off.
While I wouldn’t want to put a downer on the party, a sudden collapse in oil prices as we are seeing is not all good news. There are consequences, and the faster and further it falls, the greater those consequences could be.
Take a look at Russia: the ruble has collapsed, interest rates have foolishly been hiked from an already crucifying 10.5% to 17% this week consigning the economy to a deep recession next year and the central bank is burning through its reserves in failed attempts to support the currency and shore up the banks. Corporate Russia is deeply in debt to the outside world, mostly priced in dollars and will struggle to repay the interest on loans this coming year.
Nor is Russia alone, Venezuela is in an even worse position without Russia’s reserves, likewise Argentina, Iran and even previously booming Nigeria are now facing major problems. Turmoil in emerging markets is nothing new but has the potential to seriously upset markets at home and to destabilize banks and investors that have spent the last few years since the financial crisis chasing dwindling yields in ever more risky environments overseas.
According to the FT, investors in securitized packages of loans closer to home are scrambling to determine how much the complex products are exposed to plunging oil prices as turmoil in the US credit markets spreads. US fracking firms are said to be heavily leveraged as a result of aggressive drilling programs. As oil prices fall, investment in new wells will quite literally dry up and the ability of firms to service existing borrowings will, if they are not already, come under strain. (Speaking of strain, New York State’s Governor Andrew Cuomo just yesterday announced that he will ban fracking outright in that state.)
In the longer term, falling oil prices will lead to lower inflation and reduced pressure to raise Fed interest rates as early or as fast as they would otherwise do due to inflationary pressures. As a result, inflationary pressures from other quarters such as wages will build up unchecked and when oil prices do eventually rise, the combined impact on inflation will be that much more severe. The resulting ramp-up in rates will be steeper and, hence, more damaging than the gradual rise that is currently envisaged. So, while we fill up the tank and stride up to the kiosk with a lighter step, spare a thought for some of the consequences we may all face down the line, because there will be consequences.