The more I think about the halving of the oil price, the more significant it seems. The scale of the change makes it difficult for commentators and forecasters to think it all through and understand the magnitude of what has happened so far. There is reluctance to simply assume that in future oil revenues will be under half the levels of last year. Prices might go up again. Some of the oil is under long term contract or special arrangements which may limit the price damage a bit. Some of the industry’s commitments to put in new investments and sustain programmes of maintenance and development cannot be easily cancelled in the short term.
However, until the price rises again the safe assumption to make is that oil revenues will be well down. This means the cancellation of a large number of new projects to find and exploit oil in places where it is dear to find it and get it out. It makes the development of shale gas provinces in Europe a less immediate prospect. It means delays and cancellations to new projects in the USA. It means bankruptcies or refinancings of projects recently completed in high cost areas. It means a gradual reduction in future output to bring the market back into balance, barring some crisis to the output of one or more of the major oil producing countries or areas. Banks may need some of their new reserves to deal with extraordinary losses on oil financings.
It also means sharp contraction in state oil revenues. This will be most marked in Venezuela, already struggling with debt problems, and in Russia where oil dependence by the state is high. It also changes the once easy budget positions of various Middle Eastern countries, who have started to spend up to the revenues that oil at over $100 a barrel gave them. It will cut the oil based revenues in the UK more rapidly than the decline in output was already doing. Do not expect any PRT revenue now, and expect a big fall in oil based corporation tax receipts in a year or so. Scotland’s contribtion to UK revenues has just taken a large knock, just a few weeks after the SNP assured the people of Scotland that Scottish oil could buy them a better future.
The bad news for the few is offset for the world by the good news for the many. This level of price fall is a big boost to the large consumers like China, Japan, India and the Euro area. It takes the inflation pressure off as well, allowing easier money for longer. In the UK it is good news for the government. Although the government cannot claim it brought about the price fall by its actions, government gets blamed for anything that goes wrong on its watch and gets some benefit from what goes right, even where it is not the cause. Labour’s cost of living campaign does not look on the money now real wages are rising. Petrol at a little over £1 a litre- maybe soon at below £1 a litre – is a great refutation of Labour’s crisis talk. The banks may lose more on energy accounts, but some of their other loans may now be easier to service and refinance as many companies benefit from lower energy prices.
Overall this is good news for the world economy and good news for the real incomes of many.However, if these prices persist we should not underestimate the possible damage to the energy sector. They face, at least temporarily, the prospect of income cuts, job losses, and refinancings as they struggle to rebalance their busiensses at very different price levels.It will also change the balance between nations, putting Russia under more severe financial pressure and reducing the incomes of the Middle East.