The main reasons for the sharp drop in oil prices

Thread Content

The European Central Bank will decide at its policy meeting in December whether to expand quantitative easing, which may depend on the ECB’s assessment of the reasons behind falling oil prices. If the drop in oil prices is caused by reduced demand, the European Central Bank may expand its monetary easing measures next month. According to Bloomberg, ECB President Draghi and ECB Executive Board member and Chief Economist Peter Praet have both expressed concerns over low oil prices. Although currently low oil prices are mainly due to an oversupply of oil, benefiting both non-energy companies and households, the European Central Bank is concerned that these persistently low prices may reflect a worsening economic outlook, with the weak global economy threatening the already fragile economic recovery in the eurozone. Ben May, an economist at the Oxford Institute for Economic Policy Studies, believes that if the European Central Bank thinks that the drop in oil prices is mainly driven by demand factors, then such a drop is not so beneficial. Although low inflation rates may stimulate consumer spending in the short term, they also indicate a further decline in export demand, which has an spillover effect leading to reduced investment. According to Wall Street Journal, the Eurozone’s GDP grew by only 0.3% on a quarter-on-quarter basis in the third quarter, falling short of market expectations. Meanwhile, prices in the eurozone remain stagnant; the preliminary figure for the eurozone’s CPI in October was zero on a year-on-year basis. Core CPI, which excludes the effects of energy and food prices, rose by only 1.0% on a year-on-year basis, well below the eurozone’s inflation target of 2%. The inflation rate in the eurozone is highly dependent on demand for energy imports. Since November 2014, when OPEC decided to maintain its production limits and pursue an \"exclusion strategy\" to suppress competitors through low prices, the surplus in the crude oil market has grown increasingly severe, leading to a continuous decline in oil prices. At the beginning of 2014, the price of Brent crude oil was still at a high level of 100 dollars per barrel, but by the end of December last year it had dropped to around 60 dollars per barrel, a decline of nearly 45%. According to Wall Street Journal, data released recently by the U.S. Energy Information Administration (EIA) shows that EIA’s crude oil inventories last week approached the record high set in April of this year. After the data was released, oil prices briefly dropped below $40 per barrel. Bloomberg cited Peter Praet, a member of the European Central Bank’s executive board, as saying on Monday that in recent years the drop in oil prices was mainly due to an oversupply, which was beneficial for consumers, but the serious problem now is the weak global economy. Furthermore, ECB President Draghi also said after the decision-making meeting on October 22 that investments in oil production are to some extent based on forecasts of demand, and the decline in oil prices is caused by a reduction in demand. Michael Michaelides, a fixed-income strategist at RBS, analyzed this by saying that if the drop in oil prices is driven more by demand, then the global economic growth rate is slower than expected. With all other conditions unchanged, this means that it will be more difficult to achieve the 2% inflation target, and more aggressive stimulus measures will become justified.