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UK economy should be net winner from cheaper oil

OIL prices recovered slightly in early February, but remain a long way below the levels of about $110 (£72) per barrel seen last summer. Assuming we don’t get a rapid rebound over the next few months, what does this mean for the UK economy and business?

The first point to note is that the global economic impact should be positive. While major net oil exporters are suffering, they account for a small proportion of global GDP and their losses may be reflected in lower national savings more than reduced spending. Big emerging economies like China and India will be major winners – the US less so than before given the rise of shale oil, which is a major cause of lower prices. But it is a net importer, so should still see a net gain. This will also boost its recently rediscovered role as a key engine of global growth.

The European economy (except Norway) should also be a net winner from cheaper oil, which will provide some relief for the struggling eurozone economies. This will help UK exporters to these countries, but there should also be net benefits for the UK more directly, given that we are also now a significant net oil and gas importer.

Assuming only a gradual recovery in oil prices to about $70-80 per barrel over the next three to five years, we estimate a boost to UK GDP of about 0.5%-1%. The average household could be about £250-500 per year better off in terms of enhanced real spending power due to falls in petrol prices, domestic energy bills and other prices linked to oil. That boost will help to keep the UK consumer recovery going, and should prevent the GDP growth slowdown we saw in Q4 of 2014 continuing in 2015.

Instead, we see growth holding up at similar rates to the 2.6% seen in 2014. This would be slightly above our long-term trend rate of about 2%-2.5% and enough to keep unemployment falling through the year, perhaps to about 5% by the end of 2015. 

The big loser in all this is the UK oil and gas production sector, in the North Sea and in terms of the overseas interests of large UK companies in the sector. Some hard choices are clearly going to be made in the sector about investment and jobs, and this will hit hardest cities in like Aberdeen, where much of the North Sea-related onshore activity is based. At the same time, however, most other parts of the UK economy should be net winners. Estimating the scale of these gains at sectoral level is complex, as you need to consider all the various knock-on effects as well as the first-round revenue/cost impact of lower oil prices.

For example, past modelling by the Office for Budget Responsibility (OBR) suggests that the government will be a net winner once the boost to the non-oil economy and associated tax revenues is taken into account, as this should outweigh the loss of oil-related tax revenues (unless the oil price fall is reversed very quickly, which is possible but not most people’s expectation).

For energy-intensive industries like chemicals, airlines, heavy manufacturing, agriculture and construction, there will be a gain from lower energy input costs, though this may come through with a lag due to prior hedging of oil at earlier base price levels. How much these sectors gain will depend on how far (and how quickly) the oil price fall is passed on to customers and how far this encourages them to demand more of that product. But there should be some benefits here that should also translate into job gains.

Further down the supply chain, as consumers have more spare money, this should also benefit a wide range of consumer-facing sectors. Lower air fares may encourage holidays abroad, but also bring more visitors to the UK. In summary, cheaper oil is good news for the world and UK economies, for most industry sectors other than those involved in upstream oil and gas production, and for most households. No one can predict future oil prices with any accuracy, but we should enjoy the good news while it lasts. ?

John Hawksworth is chief economist at PwC

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