Commentary
By Alen Mattich
Wall Street Journal
Nov 28, 2014

Oil prices have fallen a long way this year. They might fall much further still.

Crude prices have fallen 36% since their summer peak, then sent into a tailspin by the failure of OPEC, the cartel of oil producing countries accounting for 40% of global supply, to trim its output quotas. And history suggests prices can fall substantially further.

It’s worth bearing in mind that for nearly two decades to 2005, crude oil prices largely ranged between $20 and $40 a barrel in today’s money. The average inflation-adjusted price of West Texas Intermediate oil since 1970 is a little under $55 a barrel compared with a little under $70 now.

That’s not to say that’s how far they’ll drop.

A rapid technical snap-back is always a possibility. But the fundamentals seem stacked towards lower rather than higher prices for now.

Which will make for some interesting economic dynamics.

Current lower gasoline prices relative to the average of the past three years will in effect put an extra $108 billion into U.S. consumers’ pockets, according to estimates by James Hamilton at the University of California, San Diego. That’s almost a 0.8% bump in disposable personal income.

Of course, what American consumers gain from, American producers lose out on. And with energy imports making up just 15% or so of U.S. consumption, according to the World Bank, the net effect on the economy would be slightly more modest.

But consider the impact of falling oil on that other major bear story, the eurozone.

It imports about 50% of its energy use–even though the per person intensity of energy consumption is less than in the U.S.

The drop in oil prices raises another dynamic here, however. Eurozone consumer price inflation has been running a mere 0.3% a year–so close to outright deflation that it’s panicking the European Central Bank. The drop in energy prices will put even more downward pressure on inflation.

ECB President Mario Draghi could well then use the falling inflation rate to call for even more aggressive monetary measures, not least outright purchases of eurozone sovereign debt. At the same time, he’d know falling energy prices would produce a fillip to the underlying economy. In other words, the slump in oil prices potentially represents a political as well as an economic windfall for the ECB.

The flip side of the eurozone’s gains from falling oil prices is, once again, the losses to oil producers. At first sight, this might appear to be a wash for the global economy. Except it’s not.

Oil revenues tend to be concentrated in the hands of a wealthy few. Increases in oil revenues don’t cause them to boost consumption by much. By the same token, falls shouldn’t result in major drops in consumption either. On the other hand, oil consumers tend to be relatively less wealthy with relatively higher propensities to spend. So the pass-through of falling oil prices is on balance positive for the global economy–it increases aggregate demand.

What the oil wealthy do, however, is reinvest their surplus into the likes of expensive art, London property and other luxuries. So, ironically, while falling oil prices might represent a boost to global growth, they might not be so favorable to some of the world’s more inflated asset classes.