Sliding Oil Price Impact on Europe
By Shuaib Bahman
The fall in oil price has not only affected oil producing countries, but it has significantly the economy of consumers. Continuing and sharp fluctuations of oil prices have had impacts on the world economy which is ending towards recession and facing instability. Many oil consumers see ambiguous perspective ahead of themselves, due to plunging oil prices.
The slump in oil prices has affected the economy of most European countries and elicited conflicting reactions. Some view the oil price fall as positive for improving the economic growth in European countries, while some others only focus on the negative consequences of this issue. Given the influential status of European countries in the world economy, the present article seeks to analyze the positive and negative effects of oil price decline on these countries.
Positive Ramifications
From certain aspects, the global fall in oil prices is viewed as a golden opportunity for the 28-nation European Union. To that effect, the falling prices may result in the following positive results for the European bloc:
The first outcome of oil price slide in Europe was that Russia’s geopolitical ambitions were curbed to some extent. Since the bulk of Russia’s state revenues come from oil and gas sales, the fall in petrodollars put a brake on some of the Kremlin’s projects for Ukraine. Moreover, the fall in energy prices pushed Russia to envisage gas deal with Europe at a time the Europeans feared that Moscow may use energy as a weapon against them in winter. In this regard, the low oil prices forced Russia to keep pumping gas to Europe in order to make up for its budget deficit stemming from low oil prices. At a time Russia’s petrodollars had fallen, cutting energy supply to Europe could inflict another blow to the Russian economy. In the face of falling oil prices, Russia had no other option but to compromise with the European countries. One should keep in mind that Russia’s gas sales to Europe makes up more than half of its gas giant Gazprom’s revenues.
Meantime, the EU is the main buyer of Russia’s gas. Europe is currently spending more than one billion Euros ($1.1 billion) on energy imports. Due to the falling oil prices, Russia had to reduce the price of its gas delivery to Europe. Gazprom is slashing the price of its 2015 gas delivery to Europe by some 35% to $222 per 1,000 cubic meters. That would bring about positive ramifications for the economy of Europe.
The second positive effect for the Europeans was its direct impact on fuel prices in most of these countries. The results could be seen in the gasoline and gasoil markets. For instance, in the Netherlands where gasoline costs high, a change in 1.56 Euros per liter of gasoline is tangible. In Italy, gasoil is heavily taxed and has now fallen to 1.45 Euros now. In Luxembourg, gasoil is sold below one Euro.
The fall in the price of car fuel has been warmly welcomed by European citizens. For instance in France, the price of gasoline was down from 1.45 Euros to 1.25 Euros per liter. As a result, airfares have become cheaper. The price of other oil derivatives has also declined. Therefore, one can conclude that the oil price fall has alleviated economic pressure on the Europeans.
The third positive outcome of oil price fall for the European countries is that they can reconsider their energy policies. The European Commission had earlier defined its energy policy based on the following pillars:
- Reducing greenhouse gas emissions
- Investment in new technologies
- Boosting energy efficiency
- Creating a single European energy market
- Diversifying sources of energy
At present, the EU can take advantage of the current environment created as a result of plunging oil and gas prices to push ahead with its project for the establishment of a Europe-wide energy forum.
One of the main elements in these projects is Europe’s dependence on Russia’s oil and gas reserves. This element has been affected by East-West tensions over Ukraine.
Negative Repercussions
Although falling oil prices could give rise to positive results for Europe’s economy, negative impacts are not ruled out. To that effect, the slump in oil prices could result in the following repercussions for European countries.
First, the slide in oil prices has brought about deflation in Europe and raised anxieties in the European Central Bank (ECB) about the possibility of an economic crisis. The main reason is the decline in inflation in eurozone and the emergence of deflation. The ECB had made relentless efforts to raise the inflation rate in the EU and particularly in the eurozone. But the sharp fall in oil prices hindered all efforts made by this European economic body.
Therefore, oil price fall has accelerated deflation which has long become a cause of concern for economic policymakers in Europe and could pose serious challenge to the economy of European governments. In case deflation continues in the EU, the dangerous cycle of profit loss, realistic pay rise, significant fall in prices, and fall in demand and further price fall would be likely.
The second negative impact of oil price fall in European countries is the decline in money supply and turnover. That would in the long term result in further fall in economic growth.
Given the fact that the eurozone is currently dealing with deflation, low oil prices may force fuel and refined products supplier companies to reduce the price of their products in the eurozone. That would naturally further reduce the amount of money in circulation in the economy of eurozone member states. That would become dangerous because demand for commodities and services will decline due to insufficient money in the cycle of economy. In that case, the purchasing power of people will decline and the general level of prices will start to fall. Under such circumstances, due to low demand for commodities and services, the economic growth in European countries and the eurozone will fall.
The third negative consequence of low oil price will involve companies active in the energy sector. These companies would face bankruptcy, and the financial markets in the world will be destabilized. For example, the fall in oil prices has imposed $4.41 billion in losses on British Petroleum (BP) during the last quarter of 2014. During the same period a year before, this British company recorded more than $1 billion in net profit. This company saw its net profit fall sharply in 2014 from the preceding year to reach $3.78 billion. BP’s net profit stood at $12.5 billion in 2013.
Under the influence of oil price fall, the net profit of Schlumberger, which is the largest company active in oil equipment and services, fell sharply. The net profit for this company was estimated at 260 million Euros for the last quarter of 2014, down from 1.66 billion Euros in 2013.
In total, oil companies have halted investment projects worth $2 trillion as the sharp decline in the oil price continues to hinder activities in the oil sector.
The sharp oil price plunge could negatively affect the activities of petrochemical plants in Europe. For example, North Sea oil fields will be shut down if oil prices fall several more dollars because in that case oil extraction will no longer be cost-effective and all relevant industries will be affected. If oil price remains unchanged below $46 a barrel, some producers in Britain will go bankrupt. The Scottish economy will also suffer an oil shock because oil production in North Sea costs more than $50 a barrel and any fall below $50 a barrel will produce losses. Therefore, oil producing countries will have to pay extra costs for the production of a barrel of oil if they intend to maintain their level of output.
In this regard, the conditions do not seem to be attractive enough for oil companies and in case oil prices keep falling a large number of producers will see their revenues fall. Any reduction in oil-related assets could accelerate move towards financial instability in the world. Oil price fall may also end in massive bankruptcy and the failure of companies in reimbursing their debts. That would have no other result but financial instability in the banks. Any decline in oil-related financial assets could negatively affect other types of assets too and lead to the spread of financial instability across other financial markets.
The fourth negative consequence of oil price fall is the emergence of wave of unemployment in European countries. For example, the oil price fall has forced BP to axe jobs. This company announced it would cut 300 jobs in North Sea so that the company would remain competitive. Schlumberger announced it would cut 9,000 jobs or 7.5% of its staff, in the face of falling oil prices.
In another case, France’s energy giant Total has adopted a measure to deal with record low oil prices. This company plans to reduce its investment to $24 billion in the exploration and operation sectors and also reduce the capacity of its refineries. That means the company would have to axe 2,000 jobs by the end of the year. Royal Dutch Shell also plans to slash 10% from its staff.
Around 17,000 jobs in the petroleum industry have been axed ever since oil prices started falling. Given the possibility of further oil price fall, that could intensify the unemployment rate in European countries and pose a serious challenge to their economies.
Two Aspects
In the short term, the fall in oil prices may prepare the ground for higher economic growth rate in Europe.
During the last quarter of 2014, the eurozone economy witnessed a quite good dynamism. The data provided by Eurostat agency showed that the economic growth in the eurozone stood at 0.3% between October and December.
Under the present circumstances, oil price fall is acting like a short-term economic prosperity plan for European countries because raw materials have acceptable price and this can help Europe improve its economic growth.
Moreover, the depreciation of the euro against the dollar coupled with oil price fall in world markets have made financiers optimistic about investment in the Eurozone. However, it seems that in the long term, oil price fall will reduce economic growth rate in industrialized European countries in Italy and Germany. The main reason is the fall in the level of investment in these countries and downturn in European stock markets.
One should bear in mind that before the start of the 2008 financial crisis in the world, oil market was witness to similar conditions. At that time, the oil prices fell and then the price of industrialized commodities declined sharply. The result was the strengthening of the US dollar and emergence of problems in the US economy and other financial markets.
A review of these events shows that everything is happening again because it has been historically registered that a decline in oil price means appreciation of the dollar and appreciation of the dollar implies the depreciation of the national currency of other countries. Therefore, faster growth of the dollar and the depreciation of currencies in some emerging economies, particularly those dependent on oil and commodity exports, will have negative consequences and a crisis similar to the 2008 tailspin is likely to strike Europe again.
Some economists in developed countries hold a positive view of the oil price fall and claim that this issue would reduce costs for both producers and consumers. However, the negative consequences of continuous sharp decline in the price of oil are likely to shadow its positive effects. This issue sounds reasonable particularly about European countries and it can pose serious challenges to their economy.