Lower oil prices don’t necessarily translate into higher economic growth, says Robeco strategist Peter van der Welle.
He says many investors have been surprised that the GDP in western economies has not been boosted in 2017 by the extra money in the pockets of consumers thanks to cheaper energy and gasoline. The price of benchmark Brent crude first began to fall in the summer of 2014, moving from a high of USD 115 a barrel to a low of USD 28 in January 2016. “The US and global economy-at-large continued to struggle throughout this period, continually lagging consensus growth estimates, despite the supposed benefit of lower oil bills,” says Van der Welle.
“For the US, there were two reasons why the benefits of lower oil prices were probably lower than expected. Firstly, as a result of the shale revolution, the US oil & gas sector has gained more importance in overall economic activity. Subsequently, the cuts in capital expenditure that accompanied the fall in the oil price as oil producers laid off rigs weighed more heavily on overall GDP growth than had been included in the forecasts.”
“Secondly, the proportion of US GDP that energy accounts for – its ‘energy intensity’ – was already on a steady downtrend, lowering the sensitivity of the sector to an oil price shock than had been experienced in the past.”
Van der Welle says the theory that the money saved by oil-importing countries would have a greater economic impact than the revenue lost by the oil producers has largely been debunked. In the past, big oil importers such as European nations were seen as being more likely to treat the money saved from lower gasoline prices as income, and then spend it, which should in theory induce a net plus for the global economy.
However, negative growth surprises in advanced economies have been regularly reported since the oil price slump. This has led to a new view that higher spending by consumers fully mitigates the negative impact of the revenue-losing oil producers, but does not exceed it.
“In other words, it is a zero-sum game, and each opposing effect cancels the other out,” Van der Welle says. “But this zero-sum game story does not fully convince, as it implies that differences in oil price sensitivity at a country level almost perfectly hedge each other on a global scale.”
“Under this logic, say a USD 1 decline in the oil price causes an increase of 0.04% in cheaper oil imports, it should simultaneously imply a decrease of 0.04% in oil exports of the oil producers. But this does not take into account differences in fossil fuel reserves, the import/export ratio of oil, its production/consumption ratio and oil’s sectoral composition, all of which are relevant for the eventual impact of an oil price shock.”
Van der Welle says the story becomes even more complicated when oil price elasticity – its ability to influence a particular economy over time – is included. Different studies already report different oil price elasticities for the same group of countries, or even the same country, over time. For example, the IMF downgraded its 2017 GDP growth forecast for Venezuela to -12% from -7.4% in just three months, as the fallout from lower oil prices developed in a nonlinear fashion.
“Despite incidences of the severe economic hardship as seen in Venezuela after the oil price slump, the absence of evidence of a positive causal relationship between low oil prices in 2014-2016 and global economic activity does not mean that it is not there in some form,” Van der Welle surmises.
“Events usually play out with variable and long lags, especially in economic analysis. So, why wouldn’t the global cyclical upswing the world has been enjoying at least partly be due to the 2014-2016 oil price slump? In early 2016, the IMF said the ‘shot in the arm’ for the global economy accruing from low oil prices had yet to materialize, as paradoxically, the benefits would appear once oil prices had recovered somewhat.”
“The reason for the surmised delay was that the oil supply shock had occurred in a low-growth environment, where central banks had already run into the ‘zero lower-bound’ problem – they were unable to further reduce nominal interest rates in order to stimulate the global economy. In this situation, falling oil prices lower inflation and raise real interest rates, choking off economic activity.”
Conversely, a recovery in oil prices would bring positive inflation surprises and the much-needed fall in real interest rates, spurring growth, he says. This can be seen in the graph below. “With hindsight, events have played out fairly well along these lines; we have experienced some reflation, and industrial production for OECD countries has indeed recovered as oil prices have rebounded,” Van der Welle explains.
“This in turn allowed the Fed to raise interest rates, moving away from the zero lower-bound problem. On the back of this, the decisive move away from the ‘bad equilibrium’ – the arrival of secular stagnation due to the zero lower-bound problem – has also fed optimism. This has become self-reinforcing, with producer confidence indices such as the German IFO indicator marking all-time highs in 2017.”
Van der Welle says there are other reasons why the positive response of economic activity to lower oil prices has been muted. The progressively higher taxation of gasoline in Europe has limited the ability of lower global crude oil prices to be passed on to lower retail gasoline prices, limiting the windfall available for European consumers.
“It all suggests that the perceived wisdom does not always manifest itself immediately,” he says.