Given the recent global sell off in oil, we thought the below excerpt from Aberdeen Asset Management’s December 2014 article titled ‘Crude awakening’ would be of interest to many of our clients pondering what a low oil price means for the global economy.
“The price of oil has been in free-fall. Brent crude has declined by
around 43 per cent since this year’s high on June 19 and at under
$66 a barrel (as of Dec 9), that’s less than half the record $146 that
the so-called ‘black gold’ reached in 2008.
Even its most fervent supporters must be suffering a crisis of faith
by now. The commodities ‘super-cycle’, championed by the likes
of billionaire investor Jim Rogers, feels somewhat remote as global
growth slows and the US represents the only glimmer of hope
among the major economies….
But the good news is that cheaper oil, and by default lower energy
and gasoline prices, can help stimulate economic activity that
could underpin an eventual recovery in many emerging countries
and, indeed, globally. Cheap oil keeps inflation low and boosts
consumer confidence. It serves, in effect, as an unofficial tax cut.
In Asia, the benefits of cheap oil can be even more far-reaching.
Countries such as India and Indonesia routinely squandered
hard-won foreign exchange to subsidise the cost of fuel as part
of populist economic policies stretching back decades. When
international oil prices soared, the strain on national budgets
Cheap oil represents an opportunity for policymakers to start
dismantling these expensive fuel subsidy schemes, while
minimising the impact on consumers. Narendra Modi’s government
in India scrapped diesel subsidies in October. His counterpart in
Indonesia, Joko Widodo, authorised a 30 per cent hike in fuel prices
the following month.
Other emerging countries are also set to benefit. South Africa,
Turkey and Poland are net oil importers, and lower prices will help
alleviate current account deficits, reduce inflation and provide
scope to potentially cut interest rates.
The big concern for many investors is that falling oil prices send
out another signal that the global engines of growth are losing
momentum. In other words, weaker prices reflect less demand.
This may be true to an extent but we firmly believe this narrative
omits an equally important observation – that falling prices also
coincide with a period when production has actually increased,
leading to excess supply.
New energy sources in the US have helped supplement traditional
supplies while projects approved when demand forecasts were
much higher are only now coming online. Meanwhile, the 12-nation
Organization of the Petroleum Exporting Countries (OPEC) decided
not to cut production last month.
Obviously none of this is particularly good news for producer
nations. But even with prices languishing around five-year lows, this
is not an existential crisis as production is generally efficient, costs
are manageable and most government financial reserves deep.
At the corporate level, cheap oil may lead to a shakeout in
companies involved in oil exploration and production. Delays
caused by regulatory and technical hurdles and projects that are
no longer commercially viable may lead to the fire-sale of assets.
Businesses that provide support for the energy sector, such as rigbuilders,
could also see their order books hit by reduced demand.
While undoubtedly painful in the short-term, this process may
be no bad thing as it will weed out unrealistic or unproductive
investments and help streamline operations over the long-run.
That said, oil prices at current levels still offer a decent, albeit
reduced, profit for major producers with global operations and
economies of scale.
Ultimately, growing populations, particularly in emerging
economies, require more oil over the long-term. Our view,
therefore, is that it is important not to overreact to short-term
price movements but to selectively own well-run, financiallyrobust
companies that can weather the current cycle”.
Source: Aberdeen Asset Management Article title: Crude awakening (December 2014) Author: Devan Kaloo, Head of Global Emerging Markets – Equities
Aberdeen Asset Management