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Business World, 26 January 2016
The conventional view is that a big plunge in oil prices would have a positive effect on the global economy; the greater the fall, the more positive the effect. Now there are reasons to believe that such a rosy view of the oil plunge may be wrong after all.
First, the global view does not take into account the asymmetric effects of oil prices fall on countries. The effect is different for oil-consuming nations than from oil-producing ones. It benefits the former and hurts the latter: the severity of the damage depending on the country’s initial condition and its dependence on oil exports.
Second, the effect of oil fluctuations may be nonlinear. Here’s what economist Paul Krugman has to say in his recent post (Jan. 26th, 2016): “A 10% or 20% decline in price might work in the conventional way. But a 70% decline has really drastic effects on producers; they become more, not less, likely to be liquidity-constrained than consumers. Saudi Arabia is forced into drastic austerity policies; highly indebted fracking companies find themselves facing balance-sheet crises. Or to put it differently: small oil price declines maybe expansionary through usual channels, but really big declines set in motion a process of forced deleveraging among producers that can be a significant drag on the world economy, especially with the whole advanced world still in or near a liquidity trap.”
Third, it matters whether it’s short term or long term. The oil price plunge makes investment in renewable energy (wind, solar, others) less attractive or relatively more expensive. Investors will think twice before they will invest in wind, solar, geothermal, or other renewable sources of energy in an extremely low oil price regime. Hence, under the present circumstances, the development of renewable energy is likely to be postponed.
IS LOWER OIL PRICES POSITIVE FOR THE PHILIPPINES AND FILIPINOS?
Car owners are big winners with pump prices only one-third of what it used to be before the oil plunge. The riding public is benefited too but to a lesser extent since adjustment of transport fares is not deregulated; price fixing continues to be administered by the government.
The government is the biggest loser. Last year, potential revenue from oil and oil products was cut by one-third. This year it could be by half.
If the government opts to adhere closely to its planned spending program, then it should accept a bigger budget deficit. But if it strictly adheres to its deficit target, then it has to reduce spending, which usually means cutting infrastructure spending. This option would be disastrous considering the Philippines’ huge deficiency in public infrastructure.
Another loser would be the Filipinos due to higher environmental costs. Right now, urban folks suffer severely from heavy traffic in Greater Metro Manila. With the cost of oil significantly down, more car owners be encouraged to drive, exacerbating the already intolerable traffic. This will add to the economic costs, which is estimated at about 7% to 8% of GDP (gross domestic product).
Another potential losers are Filipinos working abroad in oil-producing countries, which right now are in or near recession and are forced into severe austerity measures. Those working in construction are highly vulnerable.
In sum, I estimate that the effect of the oil price plunge on most Filipinos is negative.
WILL OIL PRICES STAY LOW?
It is reasonable to assume that oil prices will stay low for many years to come. Factors that explain why oil prices have remained high in the past are now changing.
First, China, the second biggest economy in the world and has been a voracious oil-guzzler in the past, is beginning to slow down. The harder it falls, the harsher the decline in oil demand. A sluggish China has a dampening economy on the rest of the world.
Second, Iran is back in the market after the economic embargo was lifted. This adds to the oil supply coming into the market.
Third, the United States has become less dependent on oil with the advent of new technologies, such as fracking.
Fourth, increased supply of renewable energy, such as solar and wind, though of a limited scale, could have a long-term meaningful impact on energy supply.
With higher supply of and more sluggish demand for oil, consumers, producers, and governments should prepare for a long period of lower consumer prices, milder inflation and lower interest rates.
What can the government do in the meantime?
With the risk of dwindling oil and oil product taxes, they should be willing to reform their oil tax system. For those governments that continue to subsidize energy consumption, this is the best time to dispose of such subsidies. It will save the government scarce public resources at a time when consumer resistance is at its lowest.
