Former Economics Editor of the NZ Herald

Brian Fallow: Bad news for oil, good news for NZ

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Bad news for oil producers has been a windfall for New Zealand consumers and businesses.
Crude oil prices hit 12-year lows this week. Could they go lower still? The answer, says the International Energy Agency, is an emphatic yes. Illustration / Anna Crichton
Crude oil prices hit 12-year lows this week. Could they go lower still? The answer, says the International Energy Agency, is an emphatic yes. Illustration / Anna Crichton

Crude oil prices hit 12-year lows this week. Could they go lower still? The answer, says the International Energy Agency, is an emphatic yes.

"Unless something changes, the oil market could drown in over-supply," the IEA says in its January Oil Market Report.

For countries which, like New Zealand, are net oil importers, plunging prices represent a windfall gain of significant scale.

The fall in petrol and diesel prices in the latest quarter would have left households and businesses around $330 million better off than in the December 2014 quarter.

It leaves consumers with more to spend on other things - timely when the labour market is very much a buyer's market and wage growth is sluggish.

And it provides some relief for business profitability at a time when, as this week's NZIER quarterly survey of business opinion attests, margins remain under pressure.

The collapse in the oil price - down more than 70 per cent from its mid-2014 peak - follows a fundamental strategic shift in Opec's policy.

Instead of responding to excess supply in the global market by cutting production to defend the price, the cartel has opted to defend market share and pump oil for all it is worth.

As recently as the September 2015 quarter, global oil demand was running at 2.1 million barrels a day (bpd) ahead of year-earlier levels, the IEA says, the strongest annual demand growth for five years.

But that was then and this is now. In the December quarter, annual demand growth fell to 1 million bpd and the agency expects demand growth this year to run around 1.2 million bpd, or about 1.3 per cent, above last year.

On the supply side, by contrast, output rose by 2.6 million bpd last year on top of a hefty 2.4 million bpd in 2014.

The IEA reckons 2016 will be the third successive year in which supply exceeds demand by more than a million barrels a day, perhaps by 1.5 million bpd in the first half of the year.

The IEA reckons 2016 will be the third successive year in which supply exceeds demand by more than a million barrels a day.

So how is Opec's strategy, led by Saudi Arabia, of letting the oil price fall in order to burn off competing supply from the likes of shale oil producers in the United States working out?

Baker Hughes, a consultancy which monitors these things, reports that this month 650 drilling rigs are operating in the US.

That sounds like a lot but it is down by more than 1000 from January last year.

It is an important indicator because shale oil producers have to keep drilling and fracking to keep the oil flowing from a "tight oil" field. That makes them more sensitive to the current oil price compared with a conventional oil field, where the costs of bringing it on stream are heavily front-loaded; once those costs are sunk, the operating cost of producing the marginal barrel is comparatively low.

Even so, the collapse in oil prices has seen an estimated US$380 billion of "upstream" expenditure - spending on looking for oil and bringing it on stream - indefinitely deferred.

This will reduce non-Opec production down the track, though environmentalists would argue it has been the height of folly for the world to spend about US$750 billion a year looking for more oil and bringing it on line when we already have more of the stuff than we can safely burn.

In the meantime, the IEA expects non-Opec production to decline by 600,000 bpd this year as US shale oil, which has been the driver of growth in non-Opec production, shrinks.

But this will inevitably be offset by increased production from Iran, now that international sanctions have been lifted, it says. Iran has indicated it can swiftly increase production by 500,000 bpd, which is only about two-thirds of the difference between what it has been producing and what it was producing in 2011 before sanctions were tightened.

Opec's policy of defending market share rather than price is far from painless, of course.

The relevant cost for Opec countries is not what it costs to physically produce the oil they export but rather the cost of the government spending funded by oil revenues.

Oil exporters' "fiscal break-even" prices - what is needed for a government to balance its books - have proven to be slippery numbers to calculate, especially for those with a floating exchange rate.

But it is unlikely there is a finance minister in any Opec country who can look at an oil price below US$30 a barrel with equanimity.

How long it is politically feasible for the cartel to maintain its current policy is anyone's guess, however.

Here in New Zealand, without the fall in petrol and diesel prices over 2015, annual CPI inflation would be 0.5 per cent, the statisticians tell us, rather than the startlingly low 0.1 per cent recorded.

The CPI reflects average prices during the quarter and prices at the pump have continued to fall.

As of last Friday, petrol prices were 5.6 per cent below the average for the December quarter.

So further downward pressure on the consumers price index from this source is to be expected, assuming the IEA knows what it is talking about.

The danger this poses from the Reserve Bank's point of view is that persistently low headline inflation drags inflation expectations lower, raising the risk that the economy gets caught in a deflationary rip.

Deflation raises the real burden of debt and that is a worry when, for example, Auckland house prices and associated debt levels rise as fast as they have been.

Unlike many other central banks, the Reserve Bank has scope to cut its policy rate. The odds that it will do so some time this year have just strengthened.

• US$45/barrel Oil price a year ago

• US$26.60/barrel Today's price

• $330m Saving for NZers in December quarter, compared with 2014

- NZ Herald

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Former Economics Editor of the NZ Herald

Brian Fallow is a former economics editor for the New Zealand Herald. A Southlander happily transplanted to Wellington, he has been a journalist since 1984 and has covered the economy and related areas of public policy for the Herald since 1995. Why the economy? Because it is where we all live and because the forces at work in it can really mess up people's lives if we are not careful.

Read more by Brian Fallow

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