Why Much Cheaper Oil Is Not All Good News
Comment of the Day

January 22 2016

Commentary by David Fuller

Why Much Cheaper Oil Is Not All Good News

After a week of turmoil, there was relief in the markets and for everyday investors on Friday. The FTSE 100 finished the week higher, giving a desperately needed fillip to the country’s depleted ISAs and pension pots; and the price of oil recovered a little. In the past, a rebound in the price of crude would have been seen as a blow, at least outside Scotland – but these days, we seem to have started cheering each time it goes up.

Why? Have we lost the plot, or is it right for the UK, paradoxically now a major net oil importer as a result of the demise of the North Sea industry, to hope for a stabilisation of the price of oil? The answer is that oil’s slump remains good news, on balance, for consumers and manufacturers. With oil production contributing far less than before to our GDP, the direct downside on that front is small.

But there are counterbalancing factors, reasons why it makes sense for the financial markets to worry, even if the ultra-pessimists are wrong.

So why is it different this time? There are five main reasons. The most interesting is that many analysts are worried about a looming energy and commodity debt crisis. Firms borrowed to invest, including for fracking and shale; but it seems that this credit could turn out to be the new subprime mortgages. The worry is that as the energy and commodities bubble continues to burst, a tidal wave of bad debt could engulf the financial system, in a repeat of the crisis of 2008.

David Fuller's view

This is a far cry from the crisis of 2008 for the USA, in my opinion.  We are only talking about the US energy sector, which is certainly not insignificant but the general public benefits from low oil prices.  In 2008 the entire US financial system and housing market was adversely affected by ‘liar loans’ and collateralized mortgage obligations (CMO’s).

Today, the problem is mainly with countries which are primarily producers of commodities, and some of the financial institutions which provided them with loans.  Nevertheless, this is a dangerous situation which can only be eased by a reasonable rally in oversold  commodity prices.

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