Why has the oil price crashed by 30 per cent – and...

Why has the oil price crashed by 30 per cent – and what does it mean for the global economy?

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What are the implications for ordinary people and the environment?

Oil prices plunged after Saudi Arabia vowed to increase production

Oil prices plunged after Saudi Arabia vowed to increase production

At the end of last week the price of a barrel of crude oil was trading in international markets at around $45.55 (£34.78).

But this morning, when markets opened again, the traded price plummeted, falling as much as a 30 per cent at one point, to just $31.29 a barrel.

The oil price is on course for it’s largest one day drop since the first Gulf War in 1991.

So why has the oil price suddenly collapsed?

What does it mean for the world economy, the environment and also for ordinary people?

What’s been moving markets?

Until today the main influence on the price of oil in recent weeks had been expectations among traders that the coronavirus would severely impact global economic activity and hence curb the demand for oil.

The price of a barrel had fallen from a recent peak of $70 in early January, amid predictions that that global oil demand this year could contract for the first time since the financial crisis.

And what changed today?

Geopolitics intervened.

Saudi Arabia, the leader of the Opec group of oil-exporting nations, had proposed they cut production in order to try to stem the falls in the global oil price, something that is damaging their state revenues.

In meetings in Vienna last week they also invited Russia, not an Opec member but another major oil-exporting nation, to join them in reducing supply.

Lower supply, all else equal, should put a floor under prices.

This is something that the Opec cartel often historically attempts when the oil price is under pressure.

But Russia signalled that it would not join in with the Opec production cuts, saying it wanted to see how the coronavirus crisis developed further, although many analysts also think Russia hopes to see rival US shale gas producers come under severe financial pressure.

Saudi Arabia, in response, reduced prices and said it would increase its own production, rather than cut it as originally planned.

That signalled a surge of new supply at a time of falling prices, hence the big drops in the price.

Why did Saudi Arabia do it?

Analysts say the Saudi kingdom’s leadership were motivated by a desire to teach Russia a lesson for its refusal to cooperate. Steep falls in the oil price put pressure on the Russian economy.

It also puts pressure on the Saudi economy but the leadership in Riyadh seems to be calculating that it will be able to cope with the impact better than Russia.

How low will oil prices go?

It is hard to say, since it may depend on the relative pain threshold of the Saudi and Russian governments for low oil prices.

“It’s still a slight hope that Saudi Arabia is playing this card in an effort to push Opec members back to the negotiation table … however Russia is unlikely to bend to such power tactics,” said Bjarne Schieldrop of the corporate bank SEB.

Some analysts today said that oil could go as low as $20 a barrel.

What does it mean for the global economy?

The huge drops in European financial markets today in response to the oil price move signals that traders think that this energy price volatility will add to the economic strain on companies, hitting profits, investment and also perhaps consumer confidence.

However, the impact is not so clear cut. Lower oil prices, if they translate into lower fuel and domestic energy prices, may also put more money in ordinary people’s pockets.

That might encourage us to spend more than we otherwise would, meaning it could act as a form of economic stimulus.

What does it mean for the environment?

Most economists believe that the most efficient way to encourage households and business to move away from polluting fossil fuels and towards carbon-free alternatives is to increase the price of those fossil fuels through taxation.

From this perspective, sharp declines in the global oil price are undesirable because they make the dominant fossil fuel cheaper and more competitive against low-carbon alternatives.

This feeds into another challenge for the UK chancellor Rishi Sunak in Wednesday’s Budget.

The government is committed to net-zero carbon emissions from the UK by 2050. But for a decade it has been cancelling scheduled rises in fuel duty in order to relieve the financial pressure on drivers. Mr Sunak had been under huge pressure to end that practice and raise fuel duty.

If he does raise it, the fall in the global oil price might make it easier to sell as the latter would cushion the financial impact on motorists.

But if Mr Sunak fails to increase fuel duty, that will arguably compound the negative environmental impact of falling oil prices and raise question marks about the credibility of the government’s emission targets.

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