Oil refinery (3)

Good news on the UK economy, and good news for half of the global economy, the oil price has seen a very rapid drop in the last few days – and the justification for the fall seems fairly substantial too. If it can stay low, then expect consumers to feel richer, and celebrate by spending more.

It was told elsewhere, see UK economy looks set to shake-off Q1 nerves – that the surveys pointed to something of a recovery in the UK economy in April. So much for the surveys. There has been some more good news, and maybe this good news is more substantive.

The oil price has fallen sharply in recent days – West Texas Intermediate oil is now costing just $44.21 a barrel, compared to $53 around a month ago. Brent crude oil is a little higher – circa $47 a barrel.

It really looked as if the oil cycle had bottomed out. In 2014, oil was trading at around $100 a barrel, a year or so later it was under $40. But then the oil cycle is like that. When the price is high, investment is high, and eventually, as a result of the high investment, supply rises. So, the oil price falls, investment falls, and then supply falls too, and the price rises, and the cycle begins all over again.

It seems that a key factor this time around is shale gas. Where shale gas differs from more conventional oil resources is that it can be turned on and off quite easily and cheaply. When oil is trading at less than $40, shale gas supply tends to fall. When oil is trading at over $50, shale gas supply rises, and thus the oil price seems to find it hard to stay at a level that is much more than $50 for any lengthy period of time, but struggles to fall much lower than the mid $40s. So, oil seems to be stuck in a range, let’s say a range between $40 and $55.

Under normal circumstances, an oil price of around $100 is good for oil exporting countries and oil companies, when it is around $50 or less, then it is good for consumers. As oil consuming countries tend to have a lower savings ratio than oil exporting countries, cheap oil should be good for the global economy as it should lead to higher spending and less saving.

But it was a serious worry that during the 2015/16 period, when oil was cheap, the global economy merely did okay. It should have boomed. In the past, oil at the that kind of price, was associated with a boom – take the late 1990s and early noughties for example, oil was cheap and growth seemed to just carry on and on – in fact the UK saw its longest ever run of uninterrupted economic growth.

Rising prices have been a worry of late – inflation has been creeping up in the US, euro area and UK. In the UK, the problem was especially pronounced because the falls in sterling exacerbated the problem. But while inflation has been rising, core inflation – with food and energy stripped out – has been rising less rapidly. In fact, in the US and euro area, core inflation has barely flickered in over a year. If the recent falls in the oil price become entrenched, then headline inflation will start to fall back. And this will be good for the US, euro area and UK.