Cheaper oil：Both symptom and balm

The oil price is tumbling. Is that good or bad newsfor the world economy?

AFTER declining gradually for three months, oilprices suddenly tumbled almost 4 on October 14th alone. It was the largest single-day fall inmore than a year and brought the price of Brent crude, an international benchmark, to 85 abarrel. At its peak in June, a barrel had cost 115.

Normally, falling oil prices would boost global growth. A 10-a-barrel fall in the oil price transfersaround 0.5% of world GDP from oil exporters to oil importers. Consumers in importingcountries are more likely to spend the money quickly than cash-rich oil exporters. By boostingspending cheaper oil therefore tends to boost global output.

This time, though, matters are less clear cut. The big economic question is whether lower pricesreflect weak demand or have been caused by a surge in the supply of crude. If weak demandis the culprit, that is worrying: it suggests the oil price is a symptom of weakening growth. Ifthe source of weakness is financial (debt overhangs and so on), then cheaper oil may notboost growth all that much: consumers may simply use the gains to pay down their debts.Indeed, in some countries, cheaper oil may even make matters worse by increasing the risk ofdeflation. On the other hand, if plentiful supply is driving prices down, that is potentiallybetter news: cheaper oil should eventually boost spending in the world's biggest economies.

The global economy is certainly weak. Japan's GDP fell in the second quarter. Germany's didtoo, and may be heading towards recession (recent figures for industrial production andexports were dreadful). America's growth has accelerated recently, but its recovery is weak byhistorical standards. Just before this week's oil-price slump, the International Monetary Fund cutits projection for global growth in 2014 for the third time this year to 3.3%. It is still expectinggrowth to pick up again in 2015, but only slightly.

Weaker growth translates into lower energy demand. This week, the International EnergyAgency, an oil importers' club, said it expects global demand to rise by just 700,000 barrels aday (b/d) this year. That is 200,000 b/d below its forecast only last month. Demand has beenweak for a while but the recent slowdown—notably in Germany—took markets by surprise,hence the sharp fall in the price.

But feeble demand is not the only explanation. There has also been a big supply shock. SinceApril last year the world's total output of oil has been rising strongly. Most months' output hasbeen 1m-2m b/d a day higher than the year before. In September, this expansion jumpeddramatically (see chart); global output was 2.8m b/d above the level of September 2013.

Most of the growth in supply has come from countries that are not members of OPEC, the oilexporters' club—from America in particular. Thanks partly to increases in shale-oil output, theUnited States pumped 8.8m b/d in September—13% more than in the year before, 56% abovethe level of 2011 and not far short of Saudi Arabia. Russian oil production is also inching up,suggesting sanctions have not yet begun to be felt in its oilfields. In September, its output roseto 10.6m b/d, within a whisker of the highest monthly figure since the collapse of the SovietUnion.

Non-OPEC production, though, has been rising for a while. The biggest recent change has comefrom within the cartel. In April, Libya's production—hit by civil war—crashed to just 200,000b/d; by the end of September output was back up to 900,000 b/d and heading towards itspre-war level of 1.5m b/d. No less surprisingly, Iraq's output is rising, too. The upshot is thatOPEC production started to grow again in September after almost two years of decline,compounding the impact of growing non-OPEC supplies.

With demand weak, much of the extra output has gone into rebuilding oil stocks in richcountries. But that cannot go on indefinitely. As the hoarding slows, prices are likely to weakenagain—unless world demand picks up or oil production is cut.

Neither seems imminent. Antoine Halff, the IEA's chief oil analyst, points out that very littlecurrent production becomes uneconomic even at 80 a barrel. The break-even point for mostAmerican shale-oil producers has been falling as they have refined their fracking techniques,and is now well below 70 a barrel. So prices will have to fall further if they are to drive marginalproducers out of business.

New trade patterns reinforce the downward pressure on prices. OPEC exporters onceinformally carved up the world between them, with Nigeria and Venezuela selling to America,smaller Gulf states to Japan, and so on. But American oil imports have fallen from 309m barrelsa month in 2010 to 236m a month now. European demand is weak. So everyone is competingfor market share in Asia.

Saudi Arabia shocked the rest of OPEC by cutting forward prices for Asian delivery and byincreasing oil output slightly in September (by 107,000 barrels), at a time when otherexporters wanted it to cut back. The organization is due to meet again in November. But asKuwait's oil minister remarked recently, “I don't think there is a chance today that [OPEC]countries would reduce their production.” How soon—and how much—lower prices will translateinto an increase in global demand, though, is far less certain.

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