The speed and magnitude of the decline in oil prices, while not unprecedented, has been dramatic and unexpected.  From a high of over $100/bbl in late June, the price of West Texas Intermediate has fallen to last Friday’s closing price of $66 (see Weekly Chart).  Based on our research sources, our best assessment of the impact of this 38% decline is a transfer of wealth from oil producers to consumers of around 1.3pp (percentage points) of global GDP, and a potential boost to global growth of between 0.25pp and 0.5pp if prices remain around current levels.  

David Fuller's view

Here is The Weekly View.

The Saudis may only achieve a Pyrrhic victory with this manoeuvre because the supply of oil pumped is exceeding global demand for it.  Consequently, they are trying to lower global oil production, notably from US shale producers, while deterring other countries from using the same technologies to develop their own shale oil and gas production capability.  Additionally, they hope to slow production from Canadian tar sands, in addition to conventional production from Russia and Iran.  If achieved, this would also weaken Iran’s nuclear and territorial ambitions, which remain major concerns for Saudi Arabia. 

There is little chance of achieving these goals in the short term, because the first response of many oil producers experiencing a shortfall of cash is to produce even more oil, as we are seeing.  There is little doubt that today’s oil prices for WTI and Brent crude will slow US shale production, and force some leveraged producers into receivership, although not as quickly as the Saudis hope because much of the output is hedged on futures markets. They will also deter the development of shale production in other countries.  Crude oil prices in the $60 region will also weaken the economies of all significant oil exporting economies, including the Saudis, although they have more currency reserves than their rivals.  Oil exporter countries may devalue but this will only cushion domestic expenditures such as subsidies and pensions, while increasing inflation and the cost of imports. 

The inevitable problem for the Saudis is that when the combination of increasing global demand for oil, plus somewhat lower production of this resource actually lifts prices back above $80 a barrel, the US shale oil industry will be back in full swing, and some other countries will try to follow its example.  The Saudis will have achieved little other than eroding their own cash reserves while also weakening OPEC’s influence. 

The Saudis and some other Middle Eastern oil producers had strong stock markets not long ago.  I would not be tempted by the current selloff.