The Effects and Outcomes of Low Oil Prices

Introduction

In the context of globalization, oil prices are turning into one of the most important economic indicators. It is crucial to study the positive and negative effects of low and high oil prices because world oil prices impact exchange rates, stock quotes, consumer and wholesale prices, making it a driving force of many economies. Oil prices have a significant effect on production costs, and forecasts of the world oil market play a role when planning state budgets and investment projects in the corporate sector.

Literature Review

The purpose of the case study is to survey the effects and outcomes of low oil prices and propose possible solutions to reverse negative results. The research by Baffes, Kose, Ohnsorge, and Stocker gives a comprehensive examination of the roots and outgrowths of oil price declines that have happened since 2014. Kilian explores the shale oil revolution in the context of oil price declines and states that oil price slumps since 2014 were partially caused by the increased production of shale oil (198). Together, these works give both a historical context on the matter and contemporary analysis of both adverse and positive influences of and reasons behind the oil price drop.

Effects of Low Oil Prices

Global GDP growth during declines in the oil price.
Figure 1. Global GDP growth during declines in the oil price (Baffes et al. 7).

Declines in oil prices have different impacts on different types of economies. In developing countries which heavily rely on imported oil, as researchers state, low oil prices will support economic growth and reduction in inflation (Baffes et al. 9). External and fiscal balances are likely to be improved as well. In theory, a fall in oil prices could lead to increased spending on other goods and services, as well as an increase in real GDP (Baffes et al. 7). The graph presented by the researches supports the claim, although current rates are lower than the historical maximum.

Low oil prices affect inflation by influencing aggregate supply and demand, and policy responses. A slump in oil prices may lead to decreased cost of production across a wide range of commodities and indirectly reduce inflation (Baffes et al. 43). Consequently, oil production will represent a lower percentage of GDP, while non-oil stocks will have an augmented position. The following graph presents that inflation dropped below the inflation target line when oil prices started declining in 2014.

Inflation expectations.
Figure 2. Inflation expectations (Baffes et al. 7).
Inflation in high-income countries.
Figure 3. Inflation in high-income countries (Baffes et al. 38).
Inflation in developing countries.
Figure 4. Inflation in developing countries (Baffes et al. 38).

This tendency is real for both high-income countries and developing economies:

Reduced prices of commodities and energy products boost the real income of consumers. This growth can translate to higher investment and increased consumption of other goods (Baffes et al. 41). However, for oil-exporting governments, there are adverse inferences in budget, funding, and unemployment. In many economies that export oil, the government heavily relies on taxing the oil-producing companies (Baffes et al. 28). Unless governments are equipped with alternative sources for funding state expenditure, they may launch a sharp fiscal consolidation. As part of the policy, they would reduce the monetary supply to contain the decline in their economy.

Possible Solutions

From a financial perspective, declining oil prices might pose hindrances to state budgets. Alternative ways of financing should be developed to reduce reliance of oil. The industry must gradually switch to clean sources of energy to ensure sustainability. Strategic planners must find ways to efficiently monetize green energy initiatives and develop successful marketing campaigns to reach a broad range of the population. The success of strategic planners would allow the government to tax the clean energy production industry to ensure appropriate state funding, and the environment would be saved. Alignment between policies could be reached through a slow penalization of oil use and promotion of alternatives among energy producers, reducing their resistance.

Factors Affecting the Oil Prices

Whether it is an investigation of the causes of high prices or low prices, several factors are universal on both occasions. These factors are how much oil is left under the Earth’s crust, access to the reservoirs, how much oil is being produced, and how much oil is demanded. While the size of total reserves is an independent variable, the other three variables are influenced by many factors. For instance, access to the reservoirs could be controlled by various policies restricting the utilization of the refineries, and the demand might increase or decrease with the advancement of electric cars. Usage of the three dependent variables, and the collection of the relevant data on each one of them for the last eight occurrences price spikes or drops may prove the correctness of the investigation.

The reason why there is no independent variable in the equation is that, at least for now, the volume of oil under the ground is enough for many years. The other three factors are in constant motion, and thus, are perfect candidates for the examination. Low demand may introduce low prices, less access may bring those prices up, and too much oil in the market can encourage the prices to go down. As there are four variables, at least 40 observations would be necessary for the assessment unless optimization methods were applied.

Conclusion

Oil is a critical commodity worldwide, and the economies of many countries are predicated on its price. As such, neither excessively high nor unusually low values for the indicator are good for the global market, as some states will begin performing poorly in either case. There is no solution to the issue within the current framework, but if humanity can reduce its reliance on oil through technological and financial means, the situation will become less volatile.

Works Cited

Baffes, John, et al. The Great Plunge in Oil Prices: Causes, Consequences, and Policy Responses. 2015. Web.

Kilian, Lutz. “The Impact of the Shale Oil Revolution on US Oil and Gasoline Prices.” Review of Environmental Economics and Policy, vol. 10, no. 2, 2016, pp. 185-205.