The Perils of Plunging Oil Prices
With the lifting of sanctions on Iran’s oil production, Greece’s largest oil refinery has agreed to be the first European buyer of Iranian crude oil since the EU ban began in 2012.
Despite Iran stating back in July that it would intensify oil exports as soon as sanctions were lifted, Middle Eastern stock markets fell by more than twenty seven billion pounds early this month in reaction to the removal of embargos on Iranian oil. As Tehran seeks to re-establish its position in the oil market, many fear that adding to the already abundant world supply of oil will suppress prices further.
In 2011 before the sanctions, Iran exported an estimated 2.5 million barrels of oil a day, in more recent times it has been closer to 1 million. Now that the sanctions have been removed Iran hopes to be exporting 2 million barrels each day by the end of the year.
The Iranian government is keen to earn the extra revenue from oil sales despite the lower prices and it has been predicted that facilitating freer trade between Iran and Western nations could bring tens of billions of dollars of international investment to the country.
Further to this, an even greater supply of oil and lower prices brings benefits to consumers. With lower transport and heating costs, households have more discretionary spending to spend as they please which can contribute to more economic growth. Likewise, for many firms a lower price of oil means lower costs of production and opportunity to gain more profitability.
However, the costs of excess supply may well undermine any such advantages. Declining oil prices are hampering oil producing firms’ profits and already forcing some to exit the market, which inevitably entails more employee redundancies. For oil exporting countries, the excess supply of oil will lead to a worsening current account deficit and a decline in tax revenues. This can account for the devaluation of the Rouble and the decline in Russian living standards, whilst the Venezuelan government struggles to meet the payments for social programs previously funded by oil tax revenue.
Moreover, as the risks associated with oil investment increases and good returns look like likely, the global financial system will be adversely effected. Banks will reduce their investment in this sector, which could lead to a reduction in global credit. Consequently, in such an environment, confidence will certainly falter and investors will become increasingly cautious.
Lower oil prices also have significant implications for inflation. Inflation is already close to zero and lower oil prices will only reduce this further, thereby creating a greater deflationary threat. As interest rates are already extremely low, central banks are likely to consistently struggle to hit their inflation targets in the near future
It is highly likely that there will also be negative impacts on the environment. Cheaper oil encourages consumption. Renewable alternatives will be less appealing to consumers if they remain comparatively expensive and any incentive for firms to invest in such resources will diminish.
Ultimately, the removal of sanctions on Iranian oil brings greater attention to the alarming problems associated with lower oil prices. Although lower prices are generally thought beneficial, in this instance such prices are already beginning to have detrimental effects on the global economy that will continue as prices continue to fall.