Cheer up! The falling oil price is great news

published 17 November 2014

141117-oil-price — A falling oil price is good for the economy

Some people just love to find a cloud for every silver lining.

I realise that, coming from me, that might sound a bit like the pot casting aspersions on the kettle's appearance. And I'll freely admit to taking a very sceptical approach to the financial world.

But I like to think I can welcome an out-and-out good news story with an open mind.

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And the collapsing price of oil is exactly that.

Falling oil prices are not deflationary

The price of crude oil just keeps tumbling. Brent is now trading at below $80 a barrel for the first time in four years. Earlier this year, it was up at more than $100 a barrel.

Now, I don't know about you, but I quite like the fact that it's cheaper to fill up my car now than it was six months ago. I don't even drive that much, but I've always viewed the petrol pump as one of the most visible cost-of-living indicators out there.

Yet, rather than cheering on falling prices, there are plenty of professional worriers out there suggesting that falling oil prices are deflationary, or that they reflect falling global demand.

I have to disagree. The idea that a falling oil price is deflationary is a classic case of lazy analysis.

Yes, headline prices might fall for a bit as transport costs drop, for example. But a similar thing would happen if you cut VAT from 20% to 15% over the course of a few months. Yet no one in their right mind would describe a tax cut as deflationary.

As I've said several times before, any money saved on filling up petrol tanks, or even on manufacturing products, is not going to be saved. It'll be spent on something else something more rewarding in most cases.

As for the idea that falling oil prices reflect falling global demand you don't need to persuade me that the global economy is fragile. And there are plenty of reasons to worry.

But the slide in oil prices has a lot more to do with there simply being much more oil than we'd expected. And that's a good thing.

This is the point of markets. The price of stuff we need goes up. Companies and individuals can afford to spend more time and money on developing technology to get more of this stuff, so they can profit from the price rise.

Eventually, they produce enough to drive the price back down, but meanwhile, they've worked out how to make the technology more efficient, so the best producers can keep producing at a profit.

So it's nice to see that some markets still function, despite the amount of interference with them that's gone on in the last decade or so.

A falling oil price could be bad news for oil producers and junk bonds

Sure, a falling oil and petrol price is bad news if you invest in the oil and gas sector. As Michael McKenzie notes in the FT, the US energy sector "has been hammered" this year even as the S&P 500 itself hits fresh records.

And, perhaps slightly worryingly for over-enthusiastic bond investors, "energy debt now accounts for nearly 16% of the US junk bond market a fourfold increase in the past decade". It's now "the second largest component of the high-yield market".

If oil prices keep falling, then companies who've borrowed money on the basis of oil prices at $100 a barrel could end up on defaulting on their debt. And that means that investors who have been carelessly reaching for yield' could have some nasty surprises lurking in their portfolios.

Even so, in the longer run, this could present some very attractive opportunities to pick up decent stocks in the sector at good prices, which is something we'll be keeping an eye on.

In any case, overall, this is a good thing for the global economy. I looked at some of the best ways to profit from a lower oil price in a recent issue of MoneyWeek magazine.

By the way, if you're not yet a subscriber, then now's a good time to take the plunge. I've just put together a special report outlining the markets we like best right now, along with the full MoneyWeek investment trust portfolio.

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John Stepek is a senior reporter at Bloomberg News and a former editor of MoneyWeek magazine. He graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.

He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news.

His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.