Cheap oil is good, right? Maybe not

Blog Post

The Dow has plummeted over the last week or so. Much of the pullback is due to concerns over the slowing Chinese economy and whether the Federal Reserve will raise interest rates for the first time in a decade. But, as is often the case when global markets shift, oil has also played a part.

The “problem” in this case is cheap oil. A year ago, oil cost around $100 per barrel. Today, that number hovers around $40 per barrel, its lowest level in over six years.

Cheap oil is good for consumers, but bad for world markets and industry. It wreaks havoc on exporting countries, particularly developing countries, many of which depend on oil to drive economic growth. Nigeria, for instance, has seen its projected revenues fall by about a third. The effects of such a dramatic and sustained drop in income can be disastrous; indeed, Nigeria reportedly is contemplating abandoning its 2015 budget altogether.

And the problem isn’t limited to new economies. In light of the recent drop in the price of oil, just last week the International Monetary Fund recommended that Saudi Arabia, the Middle East’s largest economy, “undertake a spate of fiscal changes and diversify away from its reliance on the commodity to boost growth and create jobs.”

Cheap oil also takes a toll on companies in the energy industry, and not just producers. Falling prices inevitably leads to less exploration, drilling, and production. Reduced production activity, in turn, leads to decreased demand for production inputs, like labor, steel, and heavy equipment. Layoffs and lower revenues thus ripple through various, far-reaching sectors of the industry.

These effects of cheap oil are being felt in countries around the world and, when combined with other warning signs and uncertainties (e.g., the faltering Chinese economy), cause investors to flee and markets to tumble. Given the size and complexity of the forces at play, there is little reason to believe that global markets will rebound any time soon.

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