The big economic development this year was one which no economic forecaster had predicted – a dramatic drop in the crude oil price. Brent crude has fallen around $50/barrel from the average price in 2011-13.
The most significant impact so far has been on Russia and the value of the rouble. The other very large oil producers in the world – Saudi Arabia and the United States – should be less heavily affected. The US is a net oil importer so consumers will gain more than producers lose. Saudi Arabia has very strong financial reserves to weather the storm.
However, a number of other economies are vulnerable to the downward shift in oil prices – including Nigeria, Venezuela, Angola, Iran and Iraq. Many governments in oil-producing states have expanded their budgets on the basis of strong oil revenues. If current low prices persist, or fall further, they face serious financial challenges.
Looking at the world economy as a whole, however, low oil prices should be beneficial. A fall in the oil price of the magnitude we have seen since the summer should create a boost to GDP of around one percent over the next couple of years in the major advanced economies – US, Europe and Japan. It should also benefit consumers in large emerging market economies which are net oil importers – notably China and India.
That boost comes partly through lower consumer prices. Inflation could fall to 0.5-1% in the UK and the US and consumer prices are likely to be falling in the Eurozone next year.
If lower oil prices are sustained, there should be a significant net benefit to the world economy from lower oil prices for a number of years – despite the risk of financial turbulence in the short-term, because of the negative effects on oil producers and exporters. We have seen this before. The dramatic fall in oil prices in the mid-1980s was one of the factors which helped to spur the strong growth of the late 1980s and 1990s.
But there will be winners and losers across the global economy. And the same will be true in the UK too. The public and the majority of businesses will welcome lower oil prices and a reduction in their motoring and energy costs. But there could be real problems of adjustment for UK oil producers in the North Sea, who may be gearing up investments on the assumption of a much higher oil price. And the much talked-about shale oil boom could be called into question. UK tax policies may need to change to help energy producers adapt to the new situation.
Oil prices are volatile, so it is too early to judge how long current low prices will be sustained. But for the time being consumers have reason for Christmas cheer, and oil producers face an uncertain New Year.
Andrew Sentance, is a senior economic adviser, PwC