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IMF Survey : Global Implications of Lower Oil Prices

Fracking Tower in Colorado. Shale oil, new drilling technologies account for most of the decline in oil prices says IMF staff report (Chris Rogers/Corbis)

Fracking Tower in Colorado. Shale oil, new drilling technologies account for most of the decline in oil prices says IMF staff report (Chris Rogers/Corbis)


Global Implications of Lower Oil Prices

IMF Survey

July 14, 2015

  • Supply more than demand drove oil price drop
  • Lower prices likely to persist
  • Net effect on global growth is positive

While the dramatic drop in oil prices in the past year will mean significant losses in revenue for some exporting countries, consumers should be paying less for fuel—and have more money to spend.

A new paper published by IMF staff suggests that higher spending will ultimately be good for global growth.

In an interview with IMF Survey, Aasim Husain, co-author and deputy director in the IMF’s Middle East and Central Asia Department, discusses the impact of lower oil prices on the global economy.

IMF Survey: Have the lower prices trickled down to the general population? Are people feeling the full effect of the lower oil prices, and what is the impact of that on the economy?

Husain: The decline in oil prices is certainly benefiting consumers, but not as much as we might have thought. Even though crude oil prices fell by about half between June of last year and by the end of the year, retail fuel prices on average globally have fallen by half as much, so by about a quarter.

The extent to which retail prices have fallen varies a lot across countries and regions of the world. And the reason for it is that in many countries retail prices are regulated and, in fact, in many countries retail prices are fixed. So they don’t change when world oil prices change. For example, on average in Europe, the pass-through as we call it, the extent to which retail prices change in response to changes in international crude oil prices, the pass-through has been about 80 percent in Europe. In the Americas, North and South America combined and in Asia, it was about half. So the more pass-through there is, the more the consumer benefits.

What the consumer does with this benefit, depends on what the consumer thinks, whether the decline is permanent or temporary. If it’s temporary, chances are you’re not going to alter your spending patterns very much. But if you think that this is permanent, then chances are that you will spend on other things because you’re richer effectively.

Another thing that matters in terms of how you respond is what your initial conditions are, how indebted you are. For example, if you as a consumer are overextended, you’ve got very high debts on your credit card, on your mortgage, et cetera, when you get an unexpected increase effectively in your income, then you might use that increase to pay down some of your debt.

IMF Survey: So what is at the root of this dramatic drop in oil over the past year? Is it really about a sudden increase in supply, or is it more about a changing consumer market?

Husain: It’s more supply than demand. So in other words, the shale oil revolution, the advent of better technologies, and the spread of those better technologies in order to be able to extract oil more cheaply than before, has really mattered. So it’s now less costly to produce that oil and that accounted for more than half of the decline in our estimation of the oil price that you’ve seen over the past year.

Demand also was a factor, especially in the second half of 2014. In many parts of the world, global economic indicators were coming in much weaker than had been expected and that certainly also impacted oil prices.

The two things have a very different impact on activity. So to the extent that you have supply shocks, when you find new technologies and new sources of oil such as shale, those are yours forever. But on the demand side, the weakness that we saw in 2014, part of that is already starting to go away, but certainly over time that will go away.

IMF Survey: If lower oil prices are expected to continue, how are the exporting countries expected to compensate for this lost revenue in the long term?

Husain: Oil-producing countries need to adjust to this new reality. Fortunately, many of them have during the past ten years of the oil boom accumulated substantial buffers. So that buys them time to adjust, but adjust—they will.

What can they do? Well, first a lot of their revenue comes from oil or oil-related industries. They should look to diversify that. Many of them are considering or will need to consider forms of either corporate income taxation or a value-added tax, which many of them either don’t have or have at very low levels.

An alternative is to think on the spending side. Many of them have been spending very large amounts on infrastructure and so forth, so maybe there’s room to prune there, especially as infrastructure projects get completed. But one other very interesting area where many of them could actually save is on energy subsidies or energy pricing. Many countries across the world, not just oil-producing countries, subsidize energy. And, in fact, non-oil producing countries subsidize energy directly in the sense that they sell oil products to consumers at prices lower than it costs to either import them or produce them. So that difference is borne by the government on its budget. Many oil-producing countries, on the other hand, don’t sell oil products below cost, but at prices lower than they could get if they were to sell the oil in international markets. This opportunity cost is large in some countries, and the benefits accrue mainly to the wealthy, who consume more oil than the poor.

IMF Survey: So in the end does the paper conclude that lower oil prices are good for the global economy?

Husain: I think that the outlook for the global economy because of lower oil prices is certainly positive. What we’re finding is that the positive we were expecting is taking longer to come. Part of the reason for that is that there have been other shocks along the way that have gone in the opposite direction. But I think another part of it is that the saving is being used to pay down overextended balance sheets, both by households, and by firms. So the boon from lower oil prices could take a while to come, once balance sheets have been repaired, but the repairing process is taking place faster than it otherwise would have thanks to lower oil prices.

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