Friday, 2 December 2016

OPEC Deal Could Be a Boon to World Economy Amid Shifting Dynamics

In World Economy News 02/12/2016

Global economy 02.jpg
The world’s oil cartel may have just done the global economy a big favor.
Traditional economics says a boost in oil prices—they rose more than 9% to over $49 a barrel Wednesday after the Organization of the Petroleum Exporting Countries agreed to cut output—is bad for global growth because it erodes consumer buying power, especially in the world’s largest economies.
But that view is built on experiences of the past. This time may be different, given changing dynamics in the world economy.
“Higher oil prices are good for growth,” said Jeffrey Currie, head of commodity research at Goldman Sachs.
First, higher prices should help stimulate growth in the world’s largest economic engine, the U.S. It is one of the top three oil producers in the world, pumping more than nine million barrels a day, or 10% of global consumption. As prices fell over the last two years, investment in the sector pulled back and output sank by roughly a million barrels a day.
But as prices picked up in recent months in anticipation of an OPEC deal, investment in the industry has risen. That should help push down unemployment further, pressure wages and fuel the U.S. economic expansion.
More broadly, high crude prices will help a swath of economies hurt by the two-year price plummet. Russia, Brazil, producers in the Middle East and North Africa and Nigeria—Africa’s largest economy—have all been suffering with increasing budget deficits and rising debt. The price collapse forced all of them to slash government spending—a primary driver of economic growth in most—and tilted some countries into recession. Their woes added to the headwinds facing the global economy.
Currency values—an early indicator of economic health—rose in a host oil-exporting nations around the world Wednesday, with the Russian ruble, Mexico’s peso and Canada’s dollar all seeing gains.
Higher energy costs could also counter the scourge of weak consumer-price growth in the U.S., Europe and Japan.
“I see higher oil prices as confirming the end of deflation in most countries, even possibly Japan,” said Marc Chandler, head of currency strategy at Brown Brothers Harriman.
Beyond the straightforward economic gains, Goldman Sachs’s Mr. Currie argued that an evolved global financial system upends the conventional view that higher oil prices harm the global economy. That thinking is based on the price increases of the 1970s, when higher crude costs caused a massive wealth transfer from rich economies to emerging-market exporters. Those higher-saving nations had a lower tendency to consume. And advanced economies had to less in their pocketbooks to spend on other goods and services. Combined, those factors slowed global growth.
But now, those exporting nations pour their cash back into rich economies. Unlike the 1970s, more sophisticated financial markets “were able to transform this excess savings into greater global liquidity that increased asset values, lowered interest rates, and improved credit conditions that spanned the globe,” said Mr. Currie.
As prices rise, that will juice the amount of cash and investment available globally.
Furthermore, oil prices should remain range bound, putting oil within levels that could prove optimal for the global economy.
Many economists say OPEC’s decision—if it proves a credible deal that cuts output—could push oil prices to a range of around $55 to $70 a barrel.
“Most participants would say that around $60 a barrel would be a sweet spot,” says Deutsche Bank Securities analyst Ryan Todd. “It’s not high enough to really hurt global economies, but it’s high enough for most producers to sustain a relatively attractive business model, and an attractive price for U.S. refiners.”
Even if OPEC delivers an effective cut of around 500,000 barrels a day—including the possibility of members producing over their agreed-to quotas—prices could still move into the low-to-mid $50 range, some analysts say.
That would put prices into a “Goldilocks equilibrium,” says Frank Verrastro, a top energy expert at the Center for Strategic and International Studies. That is a price balance-point “sufficient to bring in additional revenues and potentially draw down the excessive stock overhang without significantly eroding consumer demand.”
To be sure, if prices go too high—surging past $80 and into the $100 range, they could hurt world growth.
Before the 2008 financial crisis, when rich nations were booming and China’s double-digit growth fueled an 8% growth rate in emerging markets, the global economy could happily cope with $100-a-barrel oil. Now, such a boost could curb consumer spending while policy makers are still struggling to spur demand for other goods and services and trade is in long-term slump.

Source: Wall Street Journal