Fuel for Thought: The Good and Bad of Cheap Oil

Just over two weeks ago, the price of West Texas Intermediate (WTI) oil crashed to negative US$40 per barrel. At the time of writing, the price had increased to US$19.78 per barrel, however, this was still close to 70 percent lower than what it was a year ago. The current price of oil is much lower than what is required for most, if not all oil producing nations to break-even, thereby leaving some of them on the brink of economic collapse.

The price of oil matters, because oil remains the single most important commodity and its price largely determines the cost of goods and services in an economy. The price of oil is also often used as an indicator of the health of the global economy and in this regard, an oil price crash can cause even more global upheaval at a time when the world is grappling with the novel coronavirus (COVID-19) pandemic.

Oil prices are lower today for several reasons. As with most things, the law of supply and demand is usually a major factor in determining the price of goods and services. At present, as the global economy has ground to a halt due to COVID-19, the demand for oil has fallen and this has placed downward pressure on oil prices. On the supply side, there has been excess oil on the market and this situation has been exacerbated by a stand-off between Russia and Saudi Arabia in recent weeks over supply cuts, with neither country willing to reduce their production.

Lower prices might be a good thing for some owing to several factors. Lower prices help to keep inflation in check, drivers pay less for fuel at the pump, and the airline and shipping industries (responsible for transporting goods and people) can benefit from price stability. Simon Jack, Business editor for the British Broadcasting Corporation, likened a fall in the oil price to a global tax cut on businesses, big and small. To the extent that businesses pass on their cost savings to consumers, lower oil prices could serve as a tax break for said consumers. In the context of the COVID-19 pandemic, low oil prices can also aid the economic recovery that lies ahead, because cheap oil has the potential to assist economies around the world to recover more quickly from what many anticipate will be a steep global recession.

For oil producing countries, cheap oil is generally frowned on because it tends to leave them in a fiscal hole which only gets worse the longer that prices remain depressed. Essentially, many oil producing countries rely on tax revenue from oil production to fund government expenditure. When prices fall too low, these governments are then forced to either cut back on expenditure, borrow, raise taxes or a combination of each. In the CARICOM region, these might be some of the realities facing Guyana and Trinidad and Tobago, the region’s main oil producers.

There is a consensus among some analysts that oil prices will remain under pressure in the medium-term. For instance, Standard and Poor’s (S&P) Global Platts Analytics sees Brent crude trading below US$20 per barrel over the next couple of months before rebounding to US$40 a barrel by the end of 2020. Even this rebound price is low by recent standards and further depends on the timing of the economic recovery from COVID-19. Should prices remain this low as projected, many countries will need to determine the feasibility of stockpiling or locking-in oil contracts at these lower prices (if they have the finances, infrastructure and storage capacity) to buffer against any economic shock when higher prices return.

Finally, if we get used to lower oil prices, there are legitimate concerns that this could serve as a disincentive for countries to transition to renewable energy. However, the current situation is a reminder of the volatility of oil prices. With oil prices below US$20 per barrel, it might be easy to forget that there was a time in the not too distant past when they hovered around US$100 a barrel. Therefore, notwithstanding, where oil prices are now, governments should persist with their decarbonisation agendas and maintain their commitment to a future that is free of fossil fuels.