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Who Wins and Who Loses as Oil Prices Fall

Insights & Ideas Team •  December 16, 2014 | Your Finances

If you’ve put gas in your car recently, you’ve probably cheered the recent trend of falling oil prices. But is the news all good? How will this affect the world economy?

In this month’s Northwestern Mutual Perspectives podcast, Ron Joelson, executive vice president and chief investment officer at Northwestern Mutual, and Mark McLennon, vice president, Northwestern Mutual Wealth Management Company, discuss the impact of falling oil prices.

Listen to the full podcast by playing the Soundcloud above. Or read portions of the conversation below:

Mark: Some of the lower fuel prices are really compounding this long-term commodity slump, probably the longest one we’ve seen in a generation. Oil impacts a lot of things, so I thought we could dedicate this month’s chat to just that, talk a little bit about oil, maybe the pros and cons of what’s happening in that market. First of all, maybe some of the pros. Who’s really benefiting from these lower oil prices?

Ron: I think the world in general certainly will benefit. Probably the biggest to benefit are those in the agricultural sector because agriculture takes a fair amount of energy and oil. So countries like India will have a very positive impact; South Korea, they’ll probably see 2½ percent growth next year. Japan, Germany, and obviously China will have a major impact as a major consumer of oil. In the U.S., the impact is a little bit less clear. It’s going to be positive, we think. Probably as much as 1½ percent, but a lot of this does depend on the question, is it really a supply factor or is it a demand factor? It’s probably both, but you have people coming on different sides of this. So, for example, the IMF [International Monetary Fund1] attributes about 80 percent of the fall in oil prices to supply side and only 20 percent on the demand side. But J.P. Morgan economists put that ratio a lot lower, about 55 percent because of supply and the rest from weaker emerging market growth. So even the more pessimistic J.P. Morgan estimates the price decline will probably have a .7 percent positive impact on global growth.

Mark: Who’s feeling some of the strain of these record lows, and what should consumers be concerned about with lower oil prices?

Ron: Russia is going to lose. I think the latest numbers could be an almost nearly 5 percent decline in their GDP next year. If you look at countries like Venezuela, Russia and, I think, Iran falls in this category, when prices were at a $100, those were countries that didn’t squirrel anything away. When you look at Saudi Arabia, they were actually taking more reserves and being more cautious. These other countries really didn’t do that, and so now they’re probably going to be impacted worse than anybody else. And it does indicate to me countries like Saudi Arabia probably can hold off for a while in this scenario. They have built up reserves, and even though this is painful, I think they can probably withstand it.

Now, the big question—will it affect supply? I think we won’t see much of a change in the U.S. certainly next year because most of the production has been hedged at least through the first half of 2015 and possibly longer than that. But after that I do think you’ll start to see capital expenditures being cut back as far as drilling programs, and there probably will be supply cut back. I will say this, it’s very interesting to look at the impact of oil on equity markets and interest rates. If you go back 10 years, there’s been a very positive correlation between oil prices and equity markets. Now all of a sudden that calculus has changed a bit, right? So we’ve seen oil prices decline precipitously, but equities continue to rise.

So I think what we may well see is some adjustment in global growth rates. In fact, if you think about it, world GDP forecasts for the coming year have changed since July. The supply situation really hasn’t been any different, right? You can’t say that all of a sudden people didn’t know about fracking and people didn’t know about all the shale production; they did. But what has changed is the world forecast for growth. So that’s starting to make me think this is a bit more of a demand story than supply. So because the one thing that has changed has been the global forecast, I do think this in fact may well be more of a demand. And if that’s the case, we’re going to see inflation pressures, meaning deflation pressures certainly in Europe. They already have deflationary concerns; this will increase that.

Mark: You know, it wouldn’t be an economic discussion without covering rates. Last time we chatted you thought rates would start to creep up in mid-2015. Does this current oil craze change your thinking, or can you talk a little bit about the impact on inflation and interest rates?

Ron: I do think that the impact of all of this is likely to be one where the Fed may become, again, more concerned about deflation. The Fed may be less likely to raise rates in the timetable that it has been talking about.

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The opinions expressed are those of Ron Joelson and Mark McLennon as of the date stated on this article and are subject to change. There is no guarantee that the forecasts made will come to pass. This material does not constitute investment advice and is not intended as an endorsement of any specific investment. Information and opinions are derived from proprietary and non-proprietary sources.

Please remember that all investments carry some level of risk, including the potential loss of principal invested. No investment strategy can guarantee a profit or protect against a loss. Returns represent past performance, are not a guarantee of future performance and are not indicative of any specific investment.

1The International Monetary Fund (IMF) is the intergovernmental organization that oversees the global financial system by following the macroeconomic policies of its member countries, in particular those with an impact on exchange rate and the balance of payments.

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