5 Jan 2015 11:06am

Bronwen Maddox the benefits of low oil prices

Five years ago, if you said that there could be fighting in Iraq and sanctions on Iran (over its nuclear programme), and that the price of oil on world markets would nonetheless have fallen to $65 a barrel, people would have thought that you were crazy. But now it is fair to argue that we have entered an era – or at least a few years – of low oil prices.

That is good for economies that import much of their energy – for that, read the UK, the eurozone, and, indeed, China. It will underpin their growth just as that is faltering. It is, of course, bad for Russia and the oil exporters of the Gulf. It is potentially awkward for the United States, threatening to challenge the economics of fracking for shale gas, although the heady sense of independence from the turmoil of the Middle East, which now suffuses Washington on both sides of the political aisle, is surely strong enough to prevent any lurch back towards importing more energy.

Low oil prices add to the risk of deflation in the eurozone - yet the benefits surely outweigh the harm

Concerns that the low oil prices are harmful even to Europe really centre on two points. The first is climate change; they will do little to help forge a deal on carbon emissions, of the kind that will be attempted during 2015. And they add to the risk of deflation which is hovering over the eurozone, worsening its still unresolved problems. These are both important points, but all the same, the benefits of the cheap oil at this point surely outweigh the harm.


Why has the price fallen? The US’s discovery of shale gas has given it significant energy independence. China’s slowdown has curbed global demand. And Saudi Arabia’s determination not to lose market share, even if means producing at a loss, has been the third main factor. All of these have outweighed the handicaps to production in Iran and Iraq.

For European economies, this is almost entirely good news for growth – a positive supply-side shock, in the jargon. The cost of a factor of production that affects almost all parts of the economy has fallen, enabling more to be made for a lower cost. That will help the UK’s growth, which – even though still fragile – is still to be envied by much of the rest of the EU, and it will give a needed boost to continental economies, such as Germany, hit hard by the slowdown in exports to China.

But there is a sting, which is the risk of deflation, the phenomenon of falling prices and people’s expectations of falling prices, a painful economic trap now threatening the eurozone. While falling prices sound like good news, they act to discourage consumption; people simply wait before spending, reckoning that goods will get cheaper. For countries with high debt – read much of the eurozone – deflation makes the debt harder to service and pay down. The danger is that, coupled with the wider pattern of barely-rising prices, the fall in the oil price can turn into deflation. But that in itself is good news for boosting growth in a struggling region.


On climate change, too, the reasons for concern are good ones. Falling oil prices are clearly unhelpful to the new attempt at agreement on international curbs on carbon emissions, which will sprawl over the coming year. Countries have little incentive to turn their backs on a newly cheap source of energy.

But still, that is not the same as no incentive at all; the fall in the cost of solar power (more than 99 % since the late 1970s) is proving a boost to that clean technology. Car efficiency continues to rise. Research into carbon capture and storage – a way of containing emissions from burning fossil fuels – has not yet produced technology at competitive cost but is still the focus of immense attention and investment.

Meanwhile, China’s concern about the cost of pollution from burning coal and oil, in health and environmental degradation, is growing. Those factors are likely to help preserve momentum in the always difficult territory of global climate agreement.

While the fall in the oil price has rightly prompted alarm in some quarters, the help that it may give to economic growth outweighs that, especially in the still fraught eurozone.

Bronwen Maddox is editor of Prospect magazine




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