Didier Le Menestrel

OIL! OIL!

Whereas on the upmarket Avenue Kléber in Paris, a litre of petrol is still selling for €1.93, this local particularity cannot mask the global reality: since last June, oil prices have plummeted 38% in dollar terms and 31% in euro terms.   

It remains to be seen whether we should be pleased with this trend, which theoretically implies a recovery in consumer spending, or on the contrary, whether we should be alarmed and take it as a pre-cursor to a sudden slowdown in the economy.

The impact of the plunge in oil prices on consumer spending is clearly quantifiable: in the US, a gallon(1) that costs 80 cents less points to $100 billion in prospective additional spending, or $900 a year per US household. This is better than a cut in taxes and faster to transfer to the economy than Quantitative Easing measures. What could be better and why see anything else in falling oil prices other than a beneficial factor for future growth?

Flashback: while certain oil price plunges such as that in 1985 were purely due to supply shocks (at the time, a 67% nosedive prompted by higher output in Saudi Arabia), others have left more mixed memories combining a decline in GDP and plummeting oil prices. The recession in 1990 went hand-in-hand with a 56% fall in oil prices.

“Hand-in-hand” nevertheless warrants further details from a chronological stance. Were plummeting oil prices an early indicator of the slowdown to come? Or on the contrary, were we in a classic cause and effect situation, whereby the economic slowdown led to a fall in oil prices at a later stage?

More detailed analysis of these periods of volatility tend to show that in this game of chicken-and-egg, oil prices are not a good early indicator. For those for whom the 1990s seem too far off, we could start with 2008: the pace of global growth was already well in the doldrums while oil prices were still lofty ($130 in summer 2008). Only much later, after two quarters of clear economic slowdown, did oil prices start to turn down…

From a purely statistical viewpoint, the current fall in oil prices should therefore not cause concern: recent history proves that oil prices are absolutely not a trend predictor.

Oil prices might not be predictive but their fluctuations nevertheless remain mysterious. An increase was “inevitable” in 2008 and analysts were even forecasting $200/b, whereas today, surplus capacity of 1 million bpd is set to “inexorably” pull the price down to $60/b. Doom-sayers would also mention the arrival of shale gas and oil and admittedly, these 4 million bpd(2) were not in the 2008 models. However, whereas annual oil consumption is on a slightly upward and steady trend (1% in annual growth approximately), price assumptions have clearly been riddled with a string of mistakes!

Oil prices say nothing about GDP momentum, but remind us every year of a “Buffetian” saying that we love: “Forecasts may tell you a great deal about the forecaster; they tell you nothing about the future”.

Didier Le Menestrel

(1) One gallon = 3.8 litres
(2)EIA (US Energy Information Administration)