5 OIL PRICES LESSONS

The halving of oil prices over the past six months has caught pretty much every economist by surprise and prompted a rush to explain the reasons behind this astounding drop and the consequences for the global economy .

On Wednesday, the World Bank has weighed in with a study included in one of the analytical chapters of its twice-yearly Global Economic Prospects. The Bank has good reasons to study the oil price drop: the sliding cost of crude will have profound implications for growth rates, inflation outlooks and the public finances of emerging markets, whether they are oil-producers or oil-importers.

Here are five key points the World Bank makes on what is behind the oil rout and what it means for the governments of emerging markets and the global economy more generally.

1) What caused the big drop?

The Bank thinks there are four reasons behind the recent slump. First, a combination of increased supply – courtesy of the US shale industry – and falling global demand meant that the equilibrium price of crude was bound to fall. Second, OPEC's decision last November to maintain its output ceiling of 30m barrels a day signaled to world markets that the cartel was more interested in maintaining market share than in targeting a given oil price. Third, disruptions in the Middle East have been less severe than expected, meaning production in countries such as Libya has remained relatively high. Fourth, the Bank cites the appreciation of the US dollar , which rose 10 per cent against a basket of major currencies in the second half of 2014. This has squeezed the purchasing power of most importers who have to pay for dollar-priced crude using devaluing currencies.

While the report does not specify the exact contribution of each factor, Ayhan Kose, director of the Prospects Group told the FT that he thought the OPEC's decision was by far the most significant.

2) A boon for the world economy....

The World Bank expects the average price of oil in 2015 to be roughly 30 per cent less than it was in 2014. This should boost global output by 0.5 per cent in the medium term. Oil-importing emerging markets, including India, Indonesia, South Africa stand ready to gain the most, as growth accelerates and their current account deficits narrow. However, the Bank's economists believe these predictions could well be over-optimistic, for example if consumers and corporations chose to use any gains from lower oil prices to repay the debts which they are still saddled with after the financial crisis.

3) ...but a problem for some

Oil-exporters are the obvious losers from sliding oil prices. Output in Russia, as well as some states in the Middle East and North Africa could contract by 0.8-2.5 percentage points on the back of a 10 per cent decline in the annual average price of oil, the World Bank says. Some low-income countries such as Uganda and Mozambique could also be hit hard, as new investment in the energy sector is postponed or scrapped.

4) What next for monetary policy?

The World Bank sees a 30 per cent decline in oil prices cutting global inflation by 0.4-0.9 percentage points through 2015. Price pressures would then return to their old level in 2016. The advice the Washington-based economists give to central bankers in oil-importing countries is to stay put, unless there is a risk inflation expectations fall significantly (as it may be happening in the eurozone). The monetary authorities in oil-exporting countries will face a trickier balancing act, as they will have to try and foster growth, while, at the same time, keeping investors' faith in the value of their currencies.

5) And for financial markets?

The oil rout has led investors to think again about the prospects of many oil-producing emerging markets, including Russia , Venezuela and Nigeria . The risk is that plummeting currencies and equities in these countries have adverse contagion effects on other emerging markets, increasing the risk of a full-blown crisis. The World Bank is also concerned about the drying up of the flow of so-called petrodollars , the surplus savings from oil-producing countries which have boosted asset prices across the world. This could have consequences well beyond the financial markets of emerging and frontier economies.

ft.com