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The downside of cheap oil

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By Ed Crooks: 25 March 2016

Probably the greatest puzzle of the oil crash is why it hasn’t done more to strengthen global growth. The shift in purchasing power from companies and governments of oil-producing countries to consumers puts money in the pockets of people who are more likely to spend it, and that should act as a stimulus. It hasn’t quite worked out like that.

This week the FT launched a series titled ‘Lower for Longer’ exploring some of the reasons why. Number One on the list of likely explanations is the mountain of debts the industry built up during the boom times. Oil and gas company debt almost tripled from $1.1tn to $3tn between 2006 and 2014, according to the Bank for International Settlements, which has done some important research on the issue.  The oil industry, energy markets and the world economy are all struggling with the burden of that debt: the hangover after the oil investment boom of the past decade. Investors have lost at least $150bn in oil and gas company bonds, and over $2tn in equity values.

The BIS has some excellent background on oil and debt in this speech and this paper. For the definitive academic work on how investment booms rise and fall, Hyman Minsky’s ‘Stabilizing an Unstable Economy’ is a must-read, particularly chapters 7 to 9. We have compiled some of the best pieces the FT has published about the oil crash.

The International Monetary Fund also pitched in with some ideas on why the beneficial economic impact of cheap oil has been muted, including the thought that with interest rates and inflation already so low, central banks have been unable to cut rates much as inflationary pressures have eased. A blog post on the IMF website, setting out some of its thinking, says watch out for its World Economic Outlook, due next month, for more details.

Oil slipped back a couple of dollars during the week, but clung on to levels around $40 per barrel. A surge in US crude inventories suggested oversupply was still a big problem. Amy Myers Jaffe of the University of California, Davis gave an excellent overview of the state of the global oil market today. The gap between benchmark US West Texas Intermediate oil and internationally-traded Brent has closed to less than 90 cents: one reason why not much US crude is being exported, in spite of the lifting of restrictions at the end of last year.

Rosneft, the state-controlled Russian oil group, helped the country hit record post-Soviet crude production last month, but is battling against decline at mature fields.

Shale production in the US is often presented as helping efforts to tackle climate change, because gas releases less carbon dioxide than coal when used to generate electricity. However, methane, the principal component of natural gas, is also a greenhouse gas. Climate campaigner Bill McKibben argued in The Nation that leaks of methane that meant shale development could actually be worse in terms of global warming impact than using coal.

Deepwater Horizon, the feature film about the 2010 BP oil spill, will be released in the US September. The trailer makes it look pretty good; especially the visual metaphor for drilling into a reservoir.

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