Saturday, 21 February 2015

Falling Petrol Prices - Cause for Joy or Worry?

by Rosie Bell

On the long journeys into school, we scream with joy at the price of petrol, our excitement unbelievably piqued for what seems so mundane. Therefore, I decided to examine what the causes were of our fan-girl squeals; what are the implications of falling petrol prices for the British economy?

The falling petrol prices are a result of a drop in the world oil prices. This fall in prices came about as the US experienced an oil boom in 2013, which at first didn’t affect the world oil prices as the geopolitical conflicts in other major oil regions culminated in the supply of oil being maintained. On average, these conflicts took more than 3 million barrels of oil off the market per day. 

However, by mid-2014 the rising world production of oil overtook the significance of these conflicts. This growth in the supply coincided with a fall in demand for oil as cars became more efficient with better fuel consumption and weakened economies. As a result, prices in Britain have been dragged down by 11% and are still falling.

This has had a huge effect on the British economy, as the lowering petrol prices has played a large part in the fall in the consumer price index measurement for inflation which currently stands at a record low of 0.3%. George Osborne has described this as a ‘milestone for the British Economy’ and is beneficial as the consumers will be able to ‘stretch their pound’. This concept is also aided by the more money available to spend on domestically produced goods and services due to the lower fuel prices. 

A reason for worry, however, lies in the possibility of deflation. 

Deflation is a reduction of the general level of prices in an economy. This could create a problem as deflation would interfere with the nominal bank rate, which affects mortgage payments and the cash return to saving. If prices are expected to rise only slowly in the future due to the current falling prices, then for any given bank rate saving is more attractive. This rise in the ‘real’ interest rate squeezes the economy without the bank doing anything. And the bank can’t compensate for this effect by lowering the bank rate as it already stands at 0.5%. This will become a problem if the British economy faces recession in the Euro-zone.

However, for the moment we should enjoy the lowered price of petrol, although this shock to the supply of oil could rapidly change and if the lowered price results in an increase in demand this could lead to a possible long-term shortage. Therefore, a wise move for economies would be to invest more money from factors which have resulted in an increase in tax revenue into research and development for ‘green’ technology, as economies need to start aiming to reduce the consumption of oil as it is a precarious fossil fuel which is not sustainable.

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