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No OPEC Cut Needed, Says Saudi Oil Minister

Saudi Arabia’s oil minister surprised…

The Economy Needs Higher Oil Prices – Goldman Sachs

Offshore rig

OPEC is closing in on a deal to cut production, which will surely cause oil prices to rise. Oil is already almost back to $50 per barrel, so cuts of nearly 1 million barrels per day could boost prices well into the mid-$50s, even up towards $60 per barrel. That will provide a windfall to oil producers around the world and the sacrifice for OPEC members will be more than paid for by higher revenues. For example, Iraqi officials say that for every $1 increase in the price of a barrel of oil, their revenues jump by $1 billion per year.

As a result, the odds of rising crude oil prices are high. But while that could be welcomed by the industry, consumers might not be as excited to see cheap gasoline disappear. After all, U.S. motorists have enjoyed two years of incredibly cheap fuel. Will rising oil prices put a dent in already tepid U.S and global economic growth?

Perhaps not. As Bloomberg reported, Goldman Sachs wrote in a Nov. 22 research note that the global economy could benefit from higher oil prices. That conclusion may not be obvious, but here is the logic the investment bank lays out: Higher oil prices lead to a wave of capital that flows into major oil producing countries such as Saudi Arabia. Unable to use all the capital, Saudi Arabia sends the excess savings back into the global financial system. Banks then use that capital to lend. Interest rates also fall as the financial markets are more liquid. The end result is lower interest rates, more financial liquidity, higher asset values and ultimately greater consumer confidence. In short, higher oil prices could boost economic growth.

These conclusions echo those from a team of IMF economists from earlier this year. In March, the IMF said that the assumed connection between oil prices and GDP (falling oil prices will boost GDP as consumers have more money in their pockets) is not as solid as previously thought. Many analysts, including those at the IMF, once assumed that although oil producing countries such as Saudi Arabia would be damaged from low oil prices, the benefits to consuming countries would more than offset those losses, delivering net benefits to the global economy.

Related: Japan Is Aggressively Buying Up Oil And Gas Around The World

But over the past two years a surprising trend emerged. Equity prices tended to move in tandem with oil prices; in the past we had grown accustomed to expect the reverse to be true (crude prices rise, stock markets fall). The positive correlation between financial markets and crude oil prices caught many by surprise.

The reason that this unexpected link occurred has to do with monetary policy. In the past, central banks including the U.S. Fed would respond to falling oil prices with a cut in interest rates, spurring economic growth. Now, with interest rates near zero, central banks have no firepower left. Falling oil prices is causing some deflationary pressure as a result (falling asset values), and the lack of an interest rate cut means that the real interest rate is actually higher, dampening growth. As a result, the IMF economists argue that the reverse will also be true: a rise in oil prices will push up asset prices, and if central banks hold off on interest rate increases, the effect could be positive for growth.

Related: A Thanksgiving Tale: 50 Million Turkeys And A 5 Billion Mile Drive

While that explanation is convoluted and a little bit of a mouthful, Goldman Sachs’ interpretation is much simpler: An integrated financial system means that savings from oil producing countries finds its way back to consumer countries, where it can stimulate growth. The investment bank singles out the early 2000s, in which rising asset prices and global growth came even as oil prices (and prices across a range of commodities) rose substantially. “The difference between today and the 1970s is that oil creates global liquidity through a far more sophisticated financial system,” Goldman Sachs analysts wrote in their note to clients. “More sophisticated financial markets in the 2000s were able to transform this excess savings into greater global liquidity that increased asset values, lowered interest rates, and improved credit conditions that spanned the globe.”

Goldman says that the surplus in savings outside the U.S. ballooned from $1 trillion to $7 trillion between 2001 and 2014, pushing up asset prices. Of course, that can also have a darker side – asset bubbles in commodities as well as housing also led to widespread financial ruin.

All in all, the research from Goldman Sachs suggests that, while it may not be obvious to individual consumers who see higher prices at the pump, there could be a boost to the global economy in the coming months if oil prices rise.

By Nick Cunningham of Oilprice.com

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  • Kr55 on November 24 2016 said:
    Equities and oil prices can go up together to a point. You then get to a point where you are damaging disposable income in consumers and you hurt the economy that way. Right now though, everything costs decade+ lows and consumers are fine and the concern is lack of liquidity in financial systems and the general damage to them because of all the bad loans they have out there at these prices. And of course oil dependent nations are all seeing the economies in the tank which does some damage to consumption as well.
  • Jack Ma on November 25 2016 said:
    GS is describing the petrodollar system and what it fails to mention is that it only works when oil is transacted in dollars only. They cannot actually use the word petrodollar because of the age old stigma associated with this system since Bretton Woods. Did we really need GS to tell us that higher prices are good but the reinvested dollar surplus must be back into US debt or America fails and loses it's easy life. We attack and bomb any nation that transacts oil outside of dollars. We need to attack Iran now but Russia stopped the USA from gaining access into Syria and the oil pipelines needed there by the Sunni to feed Europe thus removing their dependence on Russia thus further collapsing Russia. GS also cannot use the dirty word geopolitics. Too funny so when will the world call a spade a spade. IMHO
  • Bill Simpson on November 25 2016 said:
    The growing amount of debt which has been created during the last 35 years has had an effect on global growth too. So it isn't as simple as the relationship between the oil price and growth. Debt has been growing much faster than real economic output since Reagan became president, and Wall Street discovered junk bonds. How long that can continue, who knows? I suspect it can continue until peak oil begins to force the global economy to start shrinking, as a result of less work being done. That is probably another 10 to 15 years down the road. You will know soon after peak oil arrives, without even looking at the oil production figures. No amount of fooling around with negative interest rates, or other financial engineering, will be able to save the economy when no higher price will produce more and more oil.
  • Clyde Boyd on November 26 2016 said:
    What the world really could do without is Goldman Sachs.
  • MoreFreedom on November 26 2016 said:
    This article is ridiculous. Higher oil prices only helps those who own a lot of oil, but it hurts everyone else who uses oil. Want to guess which group is far larger?

    Goldman Sachs is more interested in avoiding losses on loans to marginal oil producers, plain and simple. Many who are going under with the lower oil prices. And rightly so. This is the kind of thing that happens when bad assumptions are made about future prices. And government manipulation of interest rates to lower than what a free market would have, makes some development look profitable, when it isn't.

    The vast majority of people in the US are better off thanks to lower oil, gasoline and electricity prices, because oil producers are now actually competing against each other for market share. That's what happens in free markets.
  • Isle Oracle on November 26 2016 said:
    GS isn't talking about world economics that affect 99% if us but, they are talking about the less than1% that control 99% of the world's wealth. Only they would benefit from increased oil prices. Afterall, they are GS target audience.
  • Stephen Duval on November 27 2016 said:
    The only people who benefit from higher energy prices are OPEC. OPEC takes our money and purchases either our debt or equity in our corporations. This may be good for Goldman Sachs (transaction fees) but it is unsustainable.

    The focus of our energy policy should be to break OPEC, not to reduce CO2 emissions by raising energy prices. OPEC and the Greens are in bed otherwise the Greens would support nuclear power with zero CO2 emissions.

    The natural gas bonanza in the US can be used to displace coal, of which we have an abundant low cost supply, or to compete with oil in the transportation sector. It is obviously preferable for the US to reduce high cost, national security threatening oil imports than to leave coal in the ground. Converting natural gas to methanol for use in the transportation sector will cap the price of oil at about $50 per barrel.

    The other problem is OPEC lowering the price of oil to put the competition out of business. This is standard practice for a cartel. The threat of lower prices, Saudi Arabia can pump oil at $5 per barrel, will hinder investment in alternative fuels. What is needed is a mechanism to protect investments made at high prices from OPEC price reductions targeting competitors. When OPEC raises prices and competitive investment comes into the market, we want to make sure that the OPEC market share loss is permanent.

    This can be accomplished by the government in a revenue neutral manner. Suppose OPEC raised the price of oil to $70 per barrel by cutting production. This incentives investment in natural gas to methanol plants that are profitable at an oil price of $50. As more and more methanol plants are built, the price of oil starts falling back to $50 per barrel.

    OPEC responds by producing lots of oil, pushing the price to $30 per barrel in the expectation that all the methanol plants will go bankrupt. Suppose at this point methanol was providing 20% of the transportation market. The methanol plants require a $20 per barrel subsidy in order to be profitable and remain in operation.

    Suppose the govt imposed a tax of $4 per barrel to fund a methanol plant subsidy so that OPEC could not force the methanol plants out of business. Because only 1 of 5 barrels of oil comes from methanol (20% market share), there is 5 * $4 = $20 of subsidy available for every barrel of methanol produced. This subsidy would keep the methanol plants operational even if OPEC dropped the price of oil.

    In this manner, OPEC would have no incentive to raise the price of oil above $50 per barrel because it results in permanent loss of market share. They would have no incentive to lower the price below $50 per barrel because they would just lose money with no increase in market share.

    Consumers also benefit. Gas prices do not increase above $50 per barrel and if for some reason they fall below $50 to $30, consumers lose only $4 of the $20 per barrel decrease.

    This makes a lot more sense that pursuing high energy prices in order to reduce CO2 emissions. 97% of the global climate computer models agree, the temperature data is wrong and must be adjusted upward to agree with the computer models.
  • the wprld laughs on November 27 2016 said:
    Ha! Like we trust anything you say. How many bail outs did you get?
  • Ali ByGolli on November 27 2016 said:
    GS has zero credibility with consumers, and this latest statement is another example of why they should be ignored. Consumers don't benefit from higher oil prices; airlines don't benefit from higher prices; trucking doesn't benefit from higher prices; no one in the entire transportation industry benefits! But wait - that's no entirely correct.
    Aramco benefits
    Tesla benefits
    Al Gore benefits
    The Global Elite benefit (not enough room here to explain, but it is better than GS's BS)
    The bottom line is that GS doesn't give a crap about Joe 6 pack or the USA, and they should have been disbanded years ago.
  • Elijah Shapiro on November 30 2016 said:
    Same bullsh*t over and over again.
    It is GS who needs higher oil prices, not the american economy. They are the reason america is addicted to oil, they simply kill all other options. There is a bed in Bernie Madoff's cell with Lloyd Blankfein name written on it, wauiting for its owner.

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