“The test of a first-rate intelligence is the ability to hold two opposing ideas in mind at the same time and still retain the ability to function”. –  F Scott Fitgerald

Most of us have walked into a circle of a going conversation and heard three or four different opinions of the same topic. Seventeen hours ago oil finished 3.3 percent lower at $55.26 a barrel. It is etching lower and lower. Some has even predicted a $20 barrel.

A similarly symptomatic and dramatic occurred in 1986, when Saudi Arabia voluntarily stopped being the swing producer, forcing lower oil prices from $27 to $14 per barrel, only recovering fifteen years later, in 2000.

In the last week, we have had predictions both positive and negative, about the oil price that keeps etching lower and lower. Some market analysts have predicted a global meltdown and other predict that this will aid investment and economic development.

However, we need the sane analyst who has the two fundamental opposing views of what will really happen with sustained lower oil prices.

For today we will look at the two contrasting views, but realities of lower oil prices. Let’s start with the positive.

Firstly, every motorist who is thinking of going on a good old holiday with the family in their SUV, Motor home or with the caravan will welcome lower oil process. Another positive is that the process of etching oil prices lower allows all the efficient oil producers to produce oil and keep prices lower with over-supply in the market.

Cheaper oil is the equivalent of a weighty tax cut at an opportune time, especially for Western consumers. Just think how all those US gas guzzlers are filling up more regularly at the pumps.

Some benefits may go to governments due to the structure of how oil taxes are imposed.  Particularly Europe, the overall global ambition will be to boost consumption, lower manufacturing costs for countries consistently struggling to overcome protracted malaise in growth and jobs.

“The Saudis seem to be continuing with their game plan to shock prices lower by sticking it to the market that they will put more oil out if they have more customers for whatever price they are comfortable in selling,” said John Kilduff, partner at New York energy hedge fund Again Capital.

China used deflation in the 1990’s to boost expansion and lower oil prices also have the cause and effect of lower interest rates. For economies where there is liquidity in the market, access to finance meets the market at lower interest rates and the cost of growth is cheaper than with hyper-inflation.

On the darker side of things, we have to ask if lower cost of oil naturally lowers the cost of conversion to market costs. There does not seem to be an immediate relaxing of the cost of production of oil. Another means of effecting immediate cost reduction would be immediate retrenchments.

Lower Price Damage

But how can lower oil prices be bad you may ask? Given the new dispensation of geo-politics and economic positioning, take a closer peek at what’s really happening.

Things that go up must come down. But do things that go down always come up? Not necessary. If the oil process plunges, it may not be feasible to extract it. So lowering the cost is not as simplistic as it may sound.

Firstly, it depends on what is pushing lower prices. Some say it’s the Saudi’s and their intention to push Iran and Russia into difficulty. Others say it is demand and supply. Well stick to market manipulation by the Saudi’s.

The geo-politics tell us that Saudi Arabia is pushing purposefully pushing oil prices down to tranquilize market demand. In this way the cost of production impacts negatively on profits for Russian and Iranian Oil, both countries who experience imposed sanctions.

The cost of production remains the same due to the structure of oil companies and this hurts Russia and Iran. Then we have the negative impact on the emerging markets that may experience far less demand for their oil. In addition, demand may increase in emerging markets for traditional oil, slowing other investments.

New shale gas extractions may also be put under severe pressure, especially that the extractions still need to meet market demand in the broader international markets. This means profitability rest more in their domestic markets like the USA.

Consider that lower oil prices will lead to lower costs of ensuring products and services to rural areas and may just undermine investments in modern forms of energy i.e. renewable and clean energy.

With a global economy trying to claw its way back, lower prices of oil could also be the ‘feather that broke the camel’s back’. Shale gas extractors are heavily geared with debt and if the market demand drops due to affordable oil, we could experience a market collapse and banks and businesses could ‘fold’.

Here is the adverse effect of the free market system. This is also proof that the economic theory of demand and supply in practice differs. When oil process spike, companies quickly add the surcharges. When they come down, they remain the same for a s long as possible. The typical airline industry may choose to increase flights rather than decrease the cost of tickets.

In South Africa as an example, the rates of taxis and buses rarely are reduced when petrol prices drop and so consumers of the transport industry don’t see the immediate benefit.

The push and market dominance by Saudi Arabia may be of significance now, but to remedy from the effects of lower oil prices, especially where macro-economic systems fail, are excessively hard to recover from. The 2008 financial crisis is proof to this.

There is immediate cause and effect with emerging markets. Currency fluctuations are immediate and weak currencies from emerging markets will also slide against a currency like the dollar. The markets also have to buy oil in international currency.

“Biofuels come closest to a replacement for oil. However these are but oil-extenders. We add ethanol made from corn to gasoline to extend its quantity. But it still takes oil to operate the farm equipment to grow the corn, and oil to transport the corn to the ethanol plant. If oil isn’t around, the biofuel production system comes to a screeching halt.”

Let’s not forget governments have borrowed extensively from 2008. Domestic levels of debt in the US are naturally high and their sovereign debt is equally worrying. We have a weakened banking system in Europe and the maximum levels of debt or natural limits that countries may borrow have reached a ceiling. This calls for mechanisms and levers to ease inflation and interest rates from lower oil process. These are not without negative impact already highlighted.

Is there another means to tranquilizing the world economic situation besides lowering oil prices? Will we recover from the adverse effects of market manipulation that shows prices are over inflated?

Time will tell. In the meantime, put your seatbelt on and enjoy the ride.