Since the end of the second world war, almost every recession has been preceded by a run-up in oil prices.
From the stagflationary Arab oil embargoes of the 1970s, to the sharp rise to almost $150 a barrel on the eve of the financial crisis, few investors doubt that oil can play a big role in determining the economy’s course.
So it has been hard for many to square the dismal performance of global equities in 2016 with oil’s collapse. Since the turn of the year falling oil prices have been treated as the global economy’s lodestone, signalling everything from a slowdown in China to a potential tsunami of subprime-esque debt defaults in the energy sector that could spill into the wider economy. Equities and oil are moving in lockstep.
But are markets misreading the signals? While there are legitimate reasons to be concerned about the oil market rout, using it as a proxy for the health of the global economy appears misguided. It risks crystallising an overly pessimistic view of the world that discounts the benefits lower energy costs normally bring.
“The logic of blaming oil for everything going wrong these days is a bit perplexing,” says Amrita Sen of Energy Aspects, a London-based energy consultancy.
“If $100 oil can hurt global growth by squeezing the public finances of oil-importing nations and hobbling consumer spending, it is really hard to fathom how $20 oil can also be blamed for damaging the world economy and weighing on global stock markets.”
Those who fear that oil is heralding a rapid slowdown in global growth should take note of the fact that prices have been falling for some time, say analysts. The main driver of the 70 per cent drop in price over 18 months has been a boom in supply rather than a slowdown in demand.
“In oil what we’ve seen has primarily been a supply-side shock,” says economics professor Kamiar Mohaddes of the University of Cambridge.
“While we are also starting to see some signs of slowing demand . . . I think the close correlation between the two markets is something of an overreaction to fears of a bigger slowdown in China,” he says.
“People are seeing the impact of a massive oversupply of oil in the price and perceiving it as coming from the demand side.”
Last year Prof Mohaddes co-authored an International Monetary Fund paper that said a halving in oil prices would add 0.2 to 0.4 percentage points to global growth in the first year. In large importing countries, including most of the developed world, the impact was predicted to be closer to 1 per cent.
In Asia prices for naphtha — a type of refined oil that is an indicator of manufacturing activity — are strong relative to crude, unlike during the financial crisis when they collapsed alongside demand.
There is, of course, some linkage between falling oil prices and weak stock markets. Oil companies have fallen an average of about 20 per cent this year, making the sector one of the worst performers in London and New York.
Apple, the world’s most valuable company by market capitalisation, cited lower commodity prices as one reason for its first sales decline.
“When you think about all the commodity-driven economies — Brazil and Russia and emerging markets, but also Canada and Australia in developed markets — clearly the economy is significantly weaker than a year ago,” said Luca Maestri, Apple’s chief financial officer, on Tuesday.
Equity investors are also worried about the systemic risk from the oil price rout via industrial companies and the banking system. Several of the largest banks in the US, including Bank of America, JPMorgan Chase, Citigroup and Wells Fargo, have in recent weeks cautioned about writedowns and provisions on their oil company loans.
Their exposure is no way near the scale of the subprime crisis — BofA has $21.3bn in energy-related loans, about 3 per cent of its portfolio — but they could be forced to set aside more cash to soak up losses.
Bad energy loans can also have an impact on financial markets in other ways.
“The problem is that while a small fall in the oil price might act like a tax cut for the global economy, a large fall means significant balance sheet stress for energy producers,” says Sebastian Raedler, equity strategist at Deutsche Bank.
He estimates that “significantly stressed” US energy companies account for 20 per cent of the high-yield bond market. This is important because the risk premium in the equity market has closely tracked high-yield spreads over the past decade. If oil prices remain low and spreads widen, equities could come under more pressure.
For some the correlation between oil and equity markets is more about timing. “Low oil prices are good for the economy, but if it happens very quickly, when there’s already a lot of uncertainty, then it may be problematic,” says Martin Ellison, an economics professor at Nuffield College, Oxford.
“It’s going to produce a lot of problems in the oil industry and in the big oil-producing countries. But essentially when the oil price goes down initially things get worse, but over time the bad effects start to reverse due to the stimulating effect of lower prices.”
The 13 countries of the Opec cartel, which control about 40 per cent of world production, are likely to see their economies contact this year.
But that impact is vastly overshadowed by the benefit of lower prices for the four largest net importers — China, US, Japan and India — which make up more than 50 per cent of the world’s $77tn GDP.
“The impact of lower oil prices on producer countries is very painful individually,” says Prof Mohaddes. “But they are a small part of the overall global economy, so the boost in spending for consumers should eventually win out.”
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