About the Decline in Oil Prices..

For nearly a decade, we almost always seeing oil prices to rise steadily until around US$ 100 per barrel, except on 2008 which it dropped to US$ 45, but later went up again to the range of US$ 100 – 120 per barrel. Entering 2015, oil prices began to fall and.. all of a sudden, it is now on the level of about US$ 30 per barrel. The question, what happen? Does the decline in oil prices related to the decline in the stock markets in China, United States, and also the Jakarta Composite Index in this early of 2016?

Although the price of oil continued to climb from US$ 30 in the early decades of the 2000s to briefly topped US$ 145 per barrel in 2007, but if we look at its history since the 1860s, then by adjusting the inflation, the price of oil is more often in the range of US$ 15 – 30 per barrel. In fact, over the last 150 years, again by adjusting the inflation, the oil price only had four times at the level above US$ 100 per barrel, which in 1864 (five years after the invention of internal combustion engine, the forerunner of motor engine which uses gasoline), in 1979 (in the event of Revolution in Iran, so that the nation’s oil production stopped completely, while the country was one of the largest oil exporters in the world), in 2007 (when the speculators continue to buy oil in the futures markets so that the price soared), and between 2011 – 2014.

So when the oil price is now about US$ 30 per barrel, then historically that’s where the price should be, and the price will only go up significantly if there is a specific cause. When oil prices climbed up in the early 2000s, that specific cause was the economic boom in China, where the demand of oil jumped sharply. But after the Chinese economy slowing down recently, and will continue to slow down (with its status as the already second largest economy in the world, it would be very difficult for China to keep making outstanding economic growth as a few years ago), then so be it: Sooner or later the price oil will return to its ‘base price’. You don’t need to be a expert analyst to guess that oil prices might go down to below US$ 20 per barrel, because that is where it should be, ie in the range of US$ 15 – 30 per barrel.

Okay, but with the decline in oil prices, how it impacts the world economy?

Back in 1970s, precisely in 1973 – 1974, the price of oil jumped from previously below US$ 20 per barrel (after inflation), to exceed US$ 55 barrel, after the Arab countries stopped the export of oil to the United States and Britain, as a protest against US support for Israel who attacked Egypt and Syria. After 1974 the prices did not dropped, but continued to rise until peaked on about US$ 105 per barrel in 1979, at the onset of Iranian Revolution.

And the high price of oil, or precisely the shortages of oil supply throughout the decade of 1970s, caused a crisis in the United States and probably the world as a whole, as the economic activities that require oil had to stop. In 1973 - 1974, the American stock market crashed which S&P 500 fell more than 40% for two consecutive years, and the increase in the index in the following years throughout the decade was also insignificant (even it was fell once again in 1977).

Entering the decade of the 1980s, the commotion in the Middle East began to subside, so that the world’s oil supply back to normal.. until suddenly in 1982, the oil price was already on the level of US$ 30s per barrel again (after inflation), and continue to fall. As a result, starting in 1982 and beyond, some oil exporters such as Venezuela, Brazil, and Mexico experienced a crisis, Saudi Arabia experienced a slowdown, and even the Soviet Union broke up (to become Russia, Ukraine, Kazakhstan, and so on) in 1991. In the case of Brazil and Mexico, they experienced a crisis due to a classic issue: Debt. When the two countries had an economic boom after the rise in oil prices in the early 1970s, the Government and the private sector quickly taking a massive debt to build on this and that, and the country came to default after the oil price itself dropped. In Mexico, the crisis wasn’t fully recovered until 1984.

However, in the 1980s, several biggest oil consuming nations like the United States, Japan, and many developing countries, experienced a far better economic growth compared to the 1970s, so that the world economy as a whole also grew significantly. If we compare the movement of the Dow Jones Index in the decades of the 1970s to 1980s, then it is quite clear that the period of 1980s, when the oil price goes down, is better than the period of 1970s. Take a look at the following picture, where it was clear that the movement of the Dow between 1970 - 1980 are mostly horizontal/sideways with several extreme drops. But between 1982 - 1990, Dow successfully rose from 900 to 2,800, up more than threefold (click image to enlarge).

Dow Jones 1970 - 1990. Source: www.macrotrends.net

Between Supply and Demand

Oil prices had been relatively stable for nearly two decades, before the 2000s when it began to rise again, but this time the cause is not the decreasing supply as in 1973 when the Arab countries stopped the export of oil, but the increasing demand, which derived from the economic boom in China. Because on the other side the oil supply is still normal, then there was no crisis (unless in 2008, but the cause is not the hike in oil price, but the subprime mortgage in US).

And after the oil prices continue to fall since 2015 until its current level of US$ 30 per barrel,  whether there will be a crisis? Well, actually the question 'whether there will be a crisis' is a tricky question, because a crisis can be caused by anything, not necessarily because the rise and fall of oil prices. When Indonesia was hit by the financial crisis in 1998, there was almost no volatility in price of oil.

But if we focus on the decline in oil prices, then you may simply look at the 1980s: There wasn’t a crisis, was it? The world economy actually improved, the Dow Jones rose steadily, although some oil exporting countries were indeed experienced a crisis. Even Indonesia, which on the 1980s was also a major oil exporter, didn't experienced a slowdown.

While for the current decline in oil prices, for Indonesia it does not really matter, instead it is a good thing, considering that since 2007 we are no longer oil exporter, but instead importer. Okay, the mining industry including coal mines, which had been the backbone of Indonesia's economy rapid growth in the 2000s, may sink further with the decline in oil prices, but do not forget that the contribution of the mining sector to the national GDP is only 7.3% (until third quarter 2015), and this is very different compared to some of ‘oil barons’ like Venezuela, which 55% of its GDP comes from oil exports, or Qatar, which 60% of its GDP is derived from exports of natural gas.

Only indeed, for the year 2016, the concern is not about the decline in oil prices, but the cause of the decline itself, ie the slowdown in economic growth in China, which some people called it as a crisis (a hyperbolic terms, as always, but anyway we need to look further into it). Anyway, since the following discussion will focus on how the outlook for economic development of Indonesia, one of them if the condition of China continues to worsen (so we no longer talk about oil), then we will discuss it next week.

Any inquiries about investment in Indonesia Stock Market, please send an email to teguh@averepartners.com