Impact of Lower Oil Prices on Australia

The falls in global oil prices over the last year or so are fundamentally a reaction to oversupply in global markets – as US new oil supply comes on board, OPEC puts the squeeze on profitability of new sources of supply by refusing to cut production.

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Note: An abridged version of this note was published in the weekend Australian Financial Review (16 January 2016).

The persistent oil glut globally has had mixed effects on various countries …

The falls in global oil prices over the last year or so are fundamentally a reaction to oversupply in global markets – as US new oil supply comes on board, OPEC puts the squeeze on profitability of new sources of supply by refusing to cut production, while some traditional suppliers either add to production (e.g. Iran) or attempt to maximise production to add to their hard currency reserves (Russia).

Oil prices have taken another round of beating on China fears but is expected to be positive for global growth overall.

While recent drops to around USD 30 per barrel may be related to fears of reduced demand – notably in China – it’s worth noting that the Chinese economy (unlike its equity markets) did not fall over in the first few weeks of January. China is very much in a process of transition from an economy driven by industrial production and construction activity to one driven by the tertiary sector (consumption and other services). Thus we are still comfortable with the view that China will grow by around 6¾% this year. Clearly their economy is not crashing although it might feel like it for Australian commodity producers.

Finally, on a global basis, lower oil prices in traditional economic models are net positive for global growth – albeit with very mixed effects by region. For example some of the best known global econometric models (IMF, IMF/WEO, and Oxford – while not perfect but do at least give some independent guidance) suggest that were oil prices to remain permanently around USD 30 per barrel (rather than nearer USD 50) global GDP might, after a year or two, be around 0.4% higher – with much larger positive impacts for economies highly exposed to commodity prices such as China (0.8%) and Japan (0.7%). Clearly the results are very negative in OPEC and Russia and mixed for Australia and the USA. Of course the results are very different if lower prices are demand driven. Finally one might fret that demand is about to crunch – it may – but as noted above, equity market concerns do not necessarily equal real economy outcomes.

The implications of lower oil prices on Australia are multifaceted, but the net impact is overall assessed to be neutral

On Australia the outcomes are complicated – but are probably net positive to growth and will result in lower inflation. The latter might also increase the risk of further help via rate cuts. But lower oil prices will be especially punishing on LNG profits – via the link between long term LNG contracts and oil prices. And, via that mechanism, it will provide further substantial headwinds to government revenues.

For further information please refer to the attached note.