Commodities - FEBRUARY 2, 2016

Low oil prices

by Jeffrey Havsy

The oil supply glut has deepened these past few weeks since OPEC decided not to restrict crude production, citing expectations for an expansion in global demand of 1.3 million barrels per day in 2016 alongside a contraction in non-OPEC supply. In the United States, mild weather and still-elevated unconventional production are contributing to the market’s oversupply, depressing prices. Crude prices recently dipped below $40 per barrel for the first time since February 2009; they likely will remain at or below that level for the next six months. Looking ahead, the December congressional vote to lift the four-decade ban on U.S. crude exports could open new markets to domestic producers and improve price parity between the West Texas Intermediate and Brent indices; however, the legislation is not expected to result in higher prices.

According to the U.S. Energy Information Administration, lower gasoline prices were expected to have saved the average household $700 in 2015, relative to 2014. To put this into perspective, the Economic Stimulus Act of 2008 provided the average household with $600 to $1,200 in tax rebates, and the Federal Reserve’s monetary policy intervention has saved the average refinancing homeowner about $600 per year.

While the stimulus rebates were a one-time event, the dividend from low oil prices likely will continue for some time; savings of $700 per household could add to GDP growth for several years to come.

Estimates vary on how much consumer spending increases with a drop in oil prices. These declines range from $0.45 to $0.80 per dollar. Even the low end of this range gives consumers $45 billion dollars of additional spending power. According to a JPMorgan Chase & Co. study, 20 percent of savings on gasoline is spent on restaurants and dining.

Two scenarios for global oil prices

To date, OPEC has maintained high production levels to protect its market share from U.S. unconventional producers. In one possible scenario, acknowledging its high fiscal break-even prices, the cartel might restrict production levels at the expense of global market share. Oil prices could rebound modestly; U.S. producers consequently would increase production, using efficient and already completed wells. Break-even prices for U.S. shale oil producers would range widely from $30 to $85 per barrel, explaining why U.S. inventories continued to build, albeit at a decreasing rate.

In the second scenario, OPEC could continue to produce at high levels to protect its global market share, and the lifting of Iranian sanctions will add even more supply to the market next year. Meeting moderate demand forecasts for oil, prices could fall even further.

Currently, OPEC — led by the Saudis — is acting on the second scenario. It will be interesting to see how long it maintains this position as oil prices continue to decline. Low oil prices do have some significant consequences, with deflation being a real risk globally. Most central banks in the developed world are struggling to meet their 2 percent inflation targets, and the drop in oil prices will only add to that pressure. Add a strong dollar and the Federal Reserve raising target interest rates, and we may see the global economy readily separate into winners and losers. Emerging markets face the greatest risk, while the U.S. consumer and retail real estate are the big winners.


Jeffrey Havsy is Americas chief economist at CBRE Research and managing director, CBRE Econometric Advisors. This article was abstracted from a CBRE Viewpoint report.

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