You Need To Know This about Oil and the Global Economy

By Jacob Maines on Mar 08, 2016

In the last few years, oil prices have plummeted, and the promise of an additional supply from Iran places further downward pressure on world prices, inevitably affecting the global economy. Changes in the oil industry have a wide range of consequences around the world, good and bad. These changes result in opportunities as well as threats for global companies.

Oil impacts nearly every industry

Besides the direct consumption of oil by cars at the gas pump or by the energy sectors, oil plays a huge role in production and transportation. Changes in the price of oil affect the input costs for numerous manufacturing companies, and even food items such as oranges and strawberries will experience changes in price as transportation costs fluctuate.

The oil industry also largely impacts the banking and financial sectors of the world because oil companies require more capital in an attempt to sustain current rates of production. This is evident by the shale revolution in the US which experienced growth while oil prices were still high. With hydraulic fracking, US companies were able to glean more oil from previously “depleted” wells, but with the current fall in oil prices, this industry can no longer continue its growth. The loss of revenue affects every oil company, the industry’s supporting infrastructure, and the firms that have invested in them.

And while oil companies are experiencing great losses, the lower oil prices present a great opportunity for oil-dependent companies to cut costs and increase capital expenditure for future growth.

Low oil prices offer advantages and disadvantages to different countries

Some economies that rely on imported oil are definitely benefiting from today’s lower prices. Germany’s economy, for instance, is driven by the automobile manufacturing industry, a complement to the oil industry. Lower oil prices encourage consumers to purchase cars, and Germany’s auto industry is focused on the opportunity to expand growth to more areas in Asia, Latin America, and Africa[1].

Other economies are greatly reliant on a prosperous oil industry, so they are detrimentally affected by current low prices. For example, approximately 30% of Mexico’s public budget relies solely on income from state-owned oil company, Pemex[2]. The drop in oil prices has hurt both Mexican businesses and the livelihoods of those Mexicans who rely on government spending[3].

Effects on the global economy are volatile

In studying the past few decades, some economists believe that oil price shocks have contributed to global recessions and to economic growth, though others disagree[4]. Many people expected that the recent drop in oil prices would be a “tailwind for global growth,” but the effects have certainly not been as predicted[5]. It was expected that lower prices would represent a transfer of wealth from large producers enjoying the savings from them shifting to the masses of consumers who spend more, thereby acting as a direct stimulus to the economy. However, perhaps due to the turmoil within the oil industry over the past few decades, consumers are more likely to save their extra money when they believe that low prices are only temporary.

Low oil prices translate into decreased capital expenditure by oil companies but potential increases in investment for other sectors. According to an article in the Telegraph, “A rising oil price is both deflationary and inflationary at the same time – a poisonous economic mix if ever there was one”[6]. Moving forward, as the global economy focuses on other forms of energy, substitutes will require lots of time and greater efficiency. Carbon pricing is a potential driver of the move to alternative energy forms as it places a higher priority on decreasing pollution.

In short, the oil industry is definitely one to watch very carefully. Its volatility resounds across the entire planet and affects the decisions of many global actors and multinational corporations.

Written by Larissa Miller – International Journalism Intern – Foreign Staffing, Inc.