Cheap oil won’t save the world’s economy

Jun 26, 2012 by


Earlier this year, order buy oil prices spiked upward, site and observers worried that high prices could pinch the global economy. Then the global economy stumbled on its own — with slowdowns in the United States, China, Europe, and elsewhere — and oil prices slumped again. Crude traded in the United States sunk from $108 per barrel back in February down to $78 per barrel today. So will the reverse be true? Can low oil prices provide a stimulus?

A little, but not much. According to Andrew Kenningham, a senior economist with Capital Economics, a $20 fall in oil prices basically transfers about 1 percent of global GDP from countries that mainly produce oil (such as Russia and Saudi Arabia) to countries that mainly use oil (lots of places). Since oil-consuming countries tend to spend a bit more money on goods and services, this wealth transfer will likely boost the global economy by about 0.5 percentage points. That helps. But it’s not nearly enough to solve the world’s problems.

“Cheaper oil may cushion the fall in demand, particularly in the U.S., where the pass-through from crude oil to gasoline prices is high,” Kenningham told Housing Wire. “But it cannot reverse the slowdown.”

James Hamilton, an economist and oil expert at the University of California San Diego, concurs. He notes that gasoline prices have always tightly followed oil prices, so prices at the pump in the United States are likely to drop by quite a bit in the months ahead. That will put a little more money in the pockets of drivers. But that’s not enough of a boost to overcome all the other problems in the world:

If gasoline prices do fall from their value in April near $3.92 to $3.12, that would be an 80 cents/gallon swing. With Americans buying about 140 billion gallons of gasoline each year, that translates into an extra $112 billion over the course of a year that consumers would have available to spend on other things besides gasoline.

So should we be celebrating? I’m afraid not. The primary reason that oil prices have come down is because of growing signs of weakness in the world economy. I am very concerned about where events in Europe are going to lead, and recent U.S. data indicate some weakening. Cheap gas helps, but not so much if you don’t have a job.

The world just can’t win with oil lately. When times are good and the global economy is expanding, the world bumps against what appears to be a ceiling in the production of “easy” oil. At that point, prices tick up, threatening to squelch the recovery. Conversely, when times are bad, falling oil prices don’t appear to be enough to prop up the economy again.

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