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Impact Of Falling Oil Prices

|Includes: ConocoPhillips (COP), CVX, RIG, SLB, XOM

Summary

Lower oil price is net positive for the global economy. It is likely to add 0.8 percent to the world economy growth.

While lower oil price hurts oil companies and oilfield service providers, it is beneficial to consumers, high fuel consuming industries and oil importing countries.

With surplus production coming from non-OPEC countries,it would remain a challenge to OPEC’s effectiveness in dictating oil price to the world.

The price of crude has fallen more than 45% in last six months and touched 5-1/2-year lows. Oil price which had stayed high, hovering above $100 per barrel during last three years, is now below $60 and is poised to further drop. The supply glut caused by steep rise in shale oil production and the weakening global demand have contributed to this sharp decline in price. World oil spending constitutes around 5% of world GDP and oil plays an important role in the global economy. Let us have a look at the impact of falling oil price.

"Falling oil prices is good news for the global economy and will help boost economies," says IMF MD Christine Lagarde. Some projections reveal that it may add 0.8 percent to the world economy growth. While the drop in oil is net positive for the world, there are negatives also. To look at the impact of falling crude prices, we can classify the affected parties into four broad categories: oil producing companies, OPEC countries, oil consumers and the US Shale industry.

First, the biggest losers are oil-producing companies. Lower oil price means lower revenues and lower-profits for oil companies such as Exxon Mobil (NYSE:XOM), Chevron (NYSE:CVX) and ConocoPhillips (NYSE:COP). ExxonMobil is down 15%, Chevron by 23% and ConocoPhillips by 28% from their respective 52-week high achieved in July. However, as the average breakeven level for big oil companies is around $40 a barrel, the production will not slowdown in short term if oil price remains above the breakeven. Oil companies will be more focused on improving the productivity and flow rates of their existing wells in order to maximize returns on already invested capital. But they would cut their exploration and development spending going forward following a sharp decline in their revenues. In turn, it would lower demand for oilfield services providers such as Transocean (NYSE:RIG) and Schlumberger (NYSE:SLB). The service providers will face cash flow problems; especially the companies with high debt may feel the heat in keeping their commitment on loans and bonds.

Second, any fall in oil price is definitely a bad news for OPEC and other oil exporting countries such as Russia. These countries are set to suffer from low oil prices. Saudi and some Gulf producers can absorb it, thanks to their huge foreign exchange reserves. But Iran and other weaker OPEC countries such as Venezuela and Algeria with budgets largely dependent on oil will have to cut expenses and rebalance their budgets. Venezuela is likely to default on its debt. The slump in oil prices has already led to a weakening in the currencies of some major oil-exporting nations. Falling oil price is likely to push Russia into recession.

Third, the low price of oil is good news for consumers, who pay less for the energy. Lower crude oil prices mean cheaper gasoline at the pump and lower heating bills during winter. In the United States, the national average price of retail gasoline is now $2.55 a gallon at its lowest since 2009. Analysts believe it will drop further to $2.50 a gallon by Christmas. It is good news for car manufacturers. The other big winners are airlines as fuel forms a large part of their costs. And the same is true for other transport-related companies. Lower oil prices would mean lower input costs for the high-energy consuming companies, petrochemicals and other industries, leading to higher profit margins. IMF says that lower energy prices will add about 0.5 percent to the U.S. GDP growth. The industrialized nations such as Germany and France also stand to benefit from the price drop with an increase of about 1 percent of their GDP. Every dollar drop in the oil price reduces import bill of the net importers such as Japan, China and India. If the price remains at low level in 2015, preliminary estimate indicates this would translate into a $500 billion gain for major oil importing.

Lastly, the steep growth in oil production is the outcome of shale oil revolution in the US. Next year the US oil production is likely to approaching the historical high of 9.6 million barrels per day achieved in 1970. "The US will surpass Saudi Arabia and Russia and become the world's largest producer in near future," adds the International Energy Agency. The supply glut caused by steep rise in shale oil production is pushing price down. But a very low oil price may hit the shale oil producers also. Shale oil production from shale reservoirs using hydraulic-fracturing is costly and some analysts fear marginal wells may become uneconomical at below $60 per barrel. Saudi has launched a price war to make some upcoming shale oil projects uncompetitive. OPEC is using the strategy of low pricing to slow down the US shale industry growth. But historically oil industry is always new technologies driven, it can well be expected that research and advanced technologies will bring down cost of production of shale oil. Upward trend in shale industry growth will remain a challenge to OPEC's effectiveness in dictating oil price to the world. With surplus production coming from non-OPEC countries, oil price would be guided more by supply and demand.

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The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article.