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Oil price drop also has losers’ galley

Oil price drop also has losers’ galley
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First Published: Thu, Oct 23 2008. 10 22 PM IST

Updated: Thu, Oct 23 2008. 10 22 PM IST
Oil prices have been cut in half from their highs above $140 (Rs6,000 then) a barrel in July. They could fall further. If so, consumers around the world won’t have to choose between food and winter heating and airlines should stave off bankruptcy, at least for a while. Yet, there will be plenty of losers, too. Big energy companies, oil-enriched dictators, alternative energy suppliers and Wall Street top the list.
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Even with talk of $200 oil only recently faded, the current $70 oil is by no means a floor. Over the medium term, the price of a commodity should settle near its marginal cost of production—the most expensive barrel of oil needed to satisfy new demand. This is probably around $50 a barrel currently. Also, commodities almost always overshoot below their marginal cost of production when demand falters, as is happening now.
Among the biggest losers will be energy-dependent economies. When oil prices fall, standards of living take a hit as property and stock bubbles deflate. Russia provides an extreme example: a small number of oligarchs have lost at least $240 billion collectively on stocks, and the Moscow markets have spent much of October closed for fear of mayhem if they opened. As for the private sector, falling oil prices are likely to hit exploration and production budgets, and therefore energy equipment and services firms—perhaps to a greater extent than giant producers. The cost of delivering oil from deep-water finds off Brazil is estimated to be around $80 a barrel—higher than today’s market price.
Similarly, alternative energy producers could suffer. They have already been smacked due to their high capital intensity—wind, solar and hydropower may have low operating costs, but they are costly to install, which makes them sensitive to interest rate fluctuations and uncertainty. But politically derived subsidies are what make and break the sector. Falling energy prices may be only a temporary setback.
Finally, there’s the financial sector. Banks trade commodities, loan money to traders and invest on their own behalf. Two of the biggest growth areas for investment banks have been commodities and emerging markets. Falling oil hurts both. Half of Merrill Lynch and Co. Inc.’s “frontier index”, for example, is composed of firms from oil exporting countries.
Yet, even for the losers, there’s hope. Alternative energy sources, for instance, are still gaining ground economically as technology gets cheaper and political sensitivity about oil rises. And oil prices will cycle higher again, just as they have after declines in the past. Energy demand is growing and with prices lower, less new supply will be developed. Once demand gathers pace again, the boom will probably resume.
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First Published: Thu, Oct 23 2008. 10 22 PM IST
More Topics: Robert Cyran | Oil | Prices | Wall Street | Airlines |