Prof. Dr. Paul J.J. Welfens, Jean Monnet Professor for European Economic Integration; Chair for Macroeconomics; President of the European Institute for International Economic Relations at the University of Wuppertal, (Rainer-Gruenter-Str. 21, D-42119 Wuppertal; +49 202 4391371), Alfred Grosser Professorship 2007/08, Sciences Po, Paris, Research Fellow, IZA, Bonn, Non-Resident Senior Fellow at AICGS/Johns Hopkins University, Washington D.C. email@example.com
2015 = 20 years EIIW/award-winning research in Economics and Economic Policy
Oil price reduction is permanent * Major implications for OECD countries, China and India: economic expansion, low inflation, higher output and employment growth plus lower deficit-GDP ratios; * OPEC countries plus Russia and Brazil to face major new problems in the context of low oil prices; * Adjust investment policy in line with economic logic explained
Anti-Oil Price Shock Sustained
The 1970s witnessed two drastic oil price shocks which caused major recessions and rising inflation rates, plus higher unemployment rates as well as high deficit-GDP ratios in OECD countries. The massive fall of oil prices in 2014/2015 – by about 60% – is viewed by many observers as a transitory oil price decline. However, while some rebound effect is likely the general perception is wrong: Since 2014, there has been a massive regime switch in global oil markets and oil prices should be expected to remain low and to even decline further, to below $30 in the medium term; and it will be quite interesting to analyze the European and global effects the “anti-oil” price shock of 2014/2015 will have. The standard wisdom, maintaining that oil prices will quickly return to circa $80-100, is nonsense and therefore the implication that inflation rates could soon rise considerably is also nonsense.
The regime switch of 2014/2015 is not really well understood and the International Energy Agency is just one of the traditional forecasters who misread the international energy price dynamics. Firstly, 2014 was the first year in which investments in renewable energy in the world economy exceeded those in fossil fuel resources. This tendency should be expected to be reinforced over time and this will contribute to cutting the global oil demand substantially. The global oil and gas demand is, of course, driven by global economic growth, at the same time one should not overlook the massive technological progress in electricity grids – the development of smart grids that merge digital communication with modern electricity in a way that allows major efficiency gains leading to reduced electricity demand during the year is also a crucial element to be considered in energy markets. Moreover, the well-known progress achieved through fracking technology in oil and gas production is the second important technology factor which helps reducing the price dynamics in oil markets.
It is true that there is no symmetry between the oil price shocks of the 1970s and the anti-oil price shock of 2014/2015, as the energy intensity of production of OECD countries in 2014 was hardly half of what it had been in 1974. However, it is still clear that OECD countries, along with China and India, will benefit from the anti-oil price shock in the form of higher employment and output as well as lower inflation rates and smaller deficit-GDP ratios. The output increase in OECD countries in 2016-2020 could be around 2-3% which implies a net increase of global output if one factors in the negative output effects in OPEC countries plus Russia and Brazil – about 5-10% in the same period. Indeed, the OPEC countries, along with Russia and Brazil, are bound to suffer in the form of high exchange rate depreciation rates, rising inflation rates and higher unemployment rates, higher deficit-GDP ratios and possibly also from social and political unrest. Saudi Arabia already recorded a 15% deficit-GDP ratio in 2015 that caused government to cut subsidies for water supply, electricity prices and gas prices at the pump – moreover, they have engaged in privatizations and imposed higher excise taxes as a means to control the deficit. The sustained fall of oil prices will not only destabilize Arab oil-rich countries, but also negatively affect Venezuela and Iran whose budgets had been designed with an obvious overconfidence in stable high oil prices. Political unrest in these countries could potentially be a major problem for the future, and possibly result in new waves of refugee as well. As regards Russia, it is likely that the Russian government might want to adopt a less aggressive policy stance in the wake of low oil prices, however, President Putin might seek out foreign policy “adventures” to compensate for declining popularity in an environment of massive devaluation, recession and rising domestic prices.
The switch to a higher share of renewables in energy generation is a global one, not only because of climate policy concerns but also because the economies of scale in solar energy and wind energy generation have been considerable, and will continue to play a major role. It is not only OECD countries plus China and India which will reinforce the role of renewable energy, rather there are two additional countries with massive benefits to be expected; namely Chile and Argentina – the sustained strong winds of the southern Patagonia region could in the long run allow to produce electricity for the whole of Latin America, once massive investment in grids have been undertaken. The decline of oil prices, however, also implies a new potential problem for measures aimed at combatting climate change as low prices discourage consumers from buying more fuel-efficient cars. In this regard, policymakers should reinforce the tendency to consume energy in a more sustainable way: Subsidies for electric cars and greater support for electric trucks – with the right lane of modernized highways in the future employing an overhead electrical grid system similar to electric trains. Here massive public investment is needed in Europe, North America and China. By 2030, 90% of all transportation could be with electric vehicles powered up to 60% by electricity from renewable sources so that the majority of transportation is from renewable electricity.
The European Commission would be wise to consider such new mobility policies and here Europe could team up with China and the USA such that ambitious innovation and modernization goals could be achieved quickly and at fairly low cost. Saudi Arabia and other countries which have financed radical Islamic missionaries abroad face new constraints for such activities once the oil and gas prices have remained rather low for a number of years. From a Western perspective this is a welcome side-effect of low oil prices.