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Implications of the Oil Price Collapse

Opinion

Xconomy Boston — 

Instead of developing a warmed over list of “Top 10 Predictions for 2015,” over the past few months I have been most interested in the implications from the collapse of oil prices around the world. We will see the obvious and direct benefit to the U.S. consumer (November retail sales were up a surprising 0.7 percent) as the price of oil has declined over 40 percent since June 2014—but we might also see profound improvements in other areas of the global economy. Of course, businesses directly benefited by the high price of oil will suffer; interestingly, while the energy sector only makes up 9 percent of the S&P 500, this sector accounts for nearly 30 percent of the total associated capital expenditures—clearly there will be far reaching ripple effects across other sectors as these investment budgets are slashed.

Arguably the dramatic decline in the price of oil contributed to the increased volatility of public equities we saw during the fourth quarter of 2014. But it was not only public equity valuations which were whipsawed; fixed income securities, particularly high yield bonds, have been impacted by the price drop as investors appear to be re-assessing how appropriately risk is being priced in the market. The high yield market is particularly exposed to turmoil in the oil patch as we may see a spike in corporate defaults. All of this may directly impact the cost of capital—that is make it more expensive and/or harder for companies to raise capital on terms as favorable as we have seen the past 12 -24 months.

But the greatest impact will be felt in the global geopolitical realm. Notwithstanding numerous countervailing, and at times conflicting, forces which this price drop has unleashed, the undeniable budget pressures that have been foisted upon the economies of many of the bad acting regimes (Iran, Iraq, Russia, Venezuela come to mind) should lead to profound changes. As Tom Friedman of the New York Times recently pointed out, on the heels of significant oil price declines from 1986-1999 we saw the Soviet Union fall apart, more progressive leadership change in Iran (still far to go), and broader recognition of Israel in certain Arab states. Today we are seeing similar evidence of that behavior: Cuba normalizing relationships with the U.S. now that Venezuela is effectively bankrupt, as well as widening speculation of imminent political turmoil in Russia and Iran are just a few examples. While each of these transitions is marked with much pain and turmoil, the long-term benefits when politically corrupt oil tyrants collapse are dramatic. Interestingly, according to the World Bank, nearly 12 percent of the world’s population resides in war zones; those same geographies account for 9 percent of global oil production yet only 0.7 percent of the equity market capitalization.

Far too much collective time and energy of our world leaders is dedicated to navigating crises created by regimes propped up by high-priced oil. Idealistically, one might dream that, after certain regime changes, those same leaders would be able to focus more of their time on other pressing problems involving healthcare, the environment, education, and wealth inequities. If nothing else, unreasonably high-priced oil diverts capital away from arguably more productive uses like investing in solutions for those problems confronting us all.

[Editor’s note: To tap the wisdom of our distinguished group of Xconomists, we asked a few of them to answer this question heading into 2015: What will be the biggest surprises or breakthroughs of 2015?]

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  • Carlos Danger

    I do wonder what impact the recent decrease in oil prices will have on the rate of development of “green” energy sources. As gas prices head towards $2/gallon, it becomes more difficult to justify spending the additional cash for hybrid or electric vehicles from a purely financial perspective.