Matt Hibbard, 22 February 2016

If there’s one thing that gets up people’s noses, it’s the price of petrol. The oil price you see quoted on the nightly news can often vary dramatically with what you see at the bowser.

Whenever the oil price goes up, it always seems like petrol prices quickly follow suit. However, when the opposite happens, the price at the pump doesn’t always fall as quickly.

Of course, there’s always a reason for this. The usual argument is that the price is out of the local supplier’s control — that the price is determined by the wholesale price coming out of the refinery in Singapore.

Over the years, there’s been dozens of enquiries into the fuel industry. And every year or two, some politician decides that they’re going to be the one that brings the oil companies to heel (remember Fuelwatch?). Plenty of huffing and puffing and some furrowed brows later, and everyone moves on quietly. We’ll get ‘em next time.

While it might take time for lower oil prices to follow through to the bowser, they do get there eventually. Like what we’re seeing now. Although the ACCC are watching pretty closely to see whether any potential gauging is taking place.

For the many motorists on our roads, lower petrol prices are a good thing. Rather than spending their money on fuel, they’re going to spend their money elsewhere. And that has to be good for the economy.

Well, that’s what economic theory tells us anyway.

The theory goes something like this: rather than spending their cash on petrol, motorists will spend these extra funds on discretionary items. Like going to a restaurant, buying clothes, a new TV or couch. Perhaps they’ll take the family on a holiday.

And nearly everything you’ll ever buy has been in the back of a truck at some point in the supply chain. And cheaper freight costs should help reduce the price of goods. This too should flow through to lower prices and increase consumption.

And there are companies that have benefitted from lower fuel costs. I showed subscribers of Total Income the chart below earlier this week. It’s the share price of Qantas[ASX:QAN] in comparison to the energy index, the XEJ.

So far, Qantas has traded up, and off, the red line (support) while the energy index has hit the blue line (resistance), only to keep falling. As you’d expect, though, a reversal in oil prices could bring this trend to an end.

Working out how much lower oil prices would benefit an economy is a pretty difficult task. If you’re a country that imports oil, then lower prices are going to have an obvious benefit.

As you’d expect though, for the countries that are net exporters, a group which includes many of the emerging economies, lower oil prices have been nothing short of a disaster. Oil has been the commodity above all else that has kept their economies ticking along.

Not many predicted such dramatic falls in the oil price, but it has wreaked havoc on these countries. And the US isn’t immune. The shale oil industry at current prices is also on its knees. All are forced to keep selling product into the market to keep the cash coming in.

One thing that has shown up historically is that sharp rises in the price of oil have often coincided with downturns to the economy. That’s because there’s less money left over to spend on other things.

The test for the global economy right now, though, is whether the opposite is true. That is, whether these additional funds are finding their way into the economy through a pickup in consumption.

With the bear market in oil now entering its second year, it doesn’t yet seem as though much of these additional funds are finding their way through. Demand is still weak across many sectors, with world growth tepid at best. Global institutions, like the IMF, are still continuing to scratch a little bit of their growth forecasts every six months or so.

While most of the oil debate has focused on supply, the other side of the equation is demand. So far, demand is holding steady. The real problem for the global economy will be if this drops off. A drop in demand will mean that global growth is under even more pressure. Weaker demand will also make it harder to put a dent in the seemingly endless supply of oil.


Matt Hibbard,

Editor, Total Income

Extracted in full from Money Morning.