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Is a drop in the oil price a cause for celebration?

The oil price has fallen quite dramatically over the last few days. When I had a conversation with a colleague about this my first thought was to rejoice at the prospect of cheaper petrol prices, especially with a Devon half-term trip just around the corner. But then I stopped, and thought a little more broadly, why is the oil price falling and could it be a cause for concern?

Oil as an indicator of growth

Oil sits firmly in the commodity asset class, that means that it is basically the same regardless of who ‘makes’ it, although the big oil companies would probably like it if we had a preference.

Commodity prices are often seen as an indicator of global growth. If commodity prices go down it might be because demand has weakened, that means manufacturers are likely creating less cars, buildings, the list goes on. Now if commodity prices are weakening perhaps that demand is lower than we might think, and that points to a slowing of global growth.   

Why has the price of oil fallen?

The US has been an important  trigger of the drop in the oil price. The US oil industry has managed to make the process of extracting shale oil more efficient, they can get more at a lower cost, and so supply has increased. US production has gone up to the extent that this is undermining the cuts made in November by the Organisation of Petroleum Exporting Countries (OPEC).

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Supply is increasing, but maybe demand for oil isn’t as strong as we thought, and that’s linked to growth. China have been tightening their domestic monetary policy and they are one of the largest consumers of commodities like oil, iron ore and copper.

How could this impact wealth?

Whilst our purse strings might feel a little looser if the price of petrol drops, the oil price does impact us beyond the pump.

If this is an indication of slower global growth then the Central Banks are likely to keep interest rates lower for longer. With no respite for the cash saver on the horizon, investing your savings can be a good way to protect your money from the impact of inflation.

But when all’s said and done, we’re looking at short-term changes. On Monday my daughter wanted to be a popstar, now she wants to be an astronaut, I’m sure she’ll go through countless changes before settling on a career, and this won’t be the last change we see in the oil price.

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