Oil-price dip is no panacea

The benchmark price for U.S. crude oil dropped below $80 a barrel a few weeks ago, the lowest level since June 2012. Given the turmoil in the Middle East, the typical market response would be rising prices to compensate for expected supply shortfalls.

The falling price indicates that concern over faltering demand — weakness in the global economy — dominates market psychology. If those prices remain low, the implications will be felt around the world.

Oil prices topped $115 a barrel in June amid concerns over a supply shortfall as the global economy regained its feet. Production increased as suppliers sought to take advantage of high prices and earn revenues.

While scenes of turmoil have shaped perceptions of developments in Libya and Iraq, in fact production in those two key oil-producing states has been stable. More important in determining market trajectories has been the decision by the government of Saudi Arabia to continue production rather than cut it to keep prices high.

Meanwhile, the global recovery has softened. The United States economy has found its momentum, but it is one of the few bright spots in an otherwise dismal outlook. The prospect of growth exceeding 3 percent in the world’s biggest economy — at least for a few more months — is not enough to animate an otherwise listless world.

China, which is anticipated to surpass the U.S. as number one relatively soon, is slowing, with most experts forecasting a “new normal” of 7.5 percent. There are growing concerns about instability in the country’s financial system, real estate bubbles and an over-reliance on exports to drive growth.

Finally, there is Europe. The worst of the recent crisis there appears be over, but inflation continues to fall and the fear now is of deflation — an experience Japan knows well — and insufficient energy to make a dent in the eurozone’s 11.5 percent unemployment rate.

The 17 percent fall in the price of yen-denominated crude oil is a mixed blessing for Japan. It will make a substantial dent in the ¥17.4 trillion ($160 billion) bill that Japan paid for petroleum imports over the last 12 months. By one estimate, every $10 fall in the price of oil reduces Japan’s trade deficit — which reached 2.9 percent of GDP — by about 0.3 percent of economic output.

A corresponding reduction in input prices helps cut manufacturing costs and makes Japanese exports even more competitive, an advantage that has been facilitated by the devaluation of the yen against the dollar (and the currencies of most of its major trade rivals). Unfortunately that benefit has been reduced as many of Japan’s major manufacturers have moved production overseas.

Consumers will applaud lower gas prices. While lower prices at the pump are always welcome for consumers, they also undercut the government’s hope to attain a certain level of inflation, a core component of the “Abenomics” program.

The Abe administration has sought to end the deflation that has haunted Japan’s economy for more than a decade, and the Bank of Japan has engaged in massive and unprecedented quantitative easing to reach the goal of 2 percent inflation. That has proven difficult, and plummeting oil prices only compound the difficulties.

Other countries are also concerned about these price developments. Of course, U.S. consumers, like their Japanese counterparts, are happy to see their heating and gas bills going down. But falling oil prices reduce the allure of shale oil production, perhaps the single most important feature in the turnaround in U.S. economic fortunes. Shale oil production is likely to taper as projects look less enticing economically in comparison to traditional oil-extraction methods.

Similarly U.S. shale oil exports will become less competitive when compared to other exporters.

But if U.S. shale oil producers become irritated by that development, Washington is likely to take more solace from the larger geopolitical picture. Russia, already under real pressure as a result of sanctions imposed by Western nations as a result of its invasion and dismembering of Ukraine, is dependent on oil revenues to fund its budget: More than half its budget revenue comes from oil and gas.

There are reports that Moscow has to scale back aggressive military spending plans as a consequence of national economic difficulties. If pension and other public welfare programs are also affected, public support for President Vladimir Putin, which remains in the stratosphere, may finally erode. It is difficult to know what will temper his foreign policy, but it is hard to sustain an aggressive stance when the foundation of the economy is eroding.

Venezuela will find that its substantial oil reserves are no buffer against rising instability. Some economists anticipate a default by Caracas on its bonds if oil prices remain at their current levels. The government has already faced riots and violent demonstrations; the prospect of more cuts in subsidies and welfare programs will ratchet up domestic pressures.

The government in Iran, which, like Russia, is already feeling the squeeze of Western sanctions, will also face intensified pressure if its oil revenues remain depressed.

Of course, oil prices could rebound, and in fact, such a reversal is inevitable. The economic outlook is unlikely to change for the better, but Saudi Arabia could decide that it has made its point — that it remains central to global economic calculations.