Prediction time, and most people seem captivated by the idea that AI will in the next 12 months consign us to the dole queue, start a nuclear war, or, in the eyes of the optimists, turbocharge the world economy.
Any of those might turn out to be true, but in the short term an economic boost is more likely to come via an old-fashioned route with more predictable consequences. Oil prices are headed lower this year, pushing down inflation and giving central banks a nudge in the direction of more interest rate cuts. This might explain the curious bravado exhibited by Rachel Reeves when she appeared on Times Radio the day after the budget in November. Pressed on the Office for Budget Responsibility’s gloomy forecasts for growth over the next two years, she repeatedly said she was confident she would beat their numbers.
Falling oil prices might help; not the boost they would have been a few decades ago, when the economy was more geared to oil, but certainly a gentle shove in the right direction.
Predicting oil prices, of course, is a mug’s game, particularly if you are trying to look more than a few months ahead. There are too many variables, many of them political, which can make a monkey of the best-informed analyst. Having given that caveat, there is a wealth of evidence pointing towards lower prices.
They have already fallen quite far. A year ago Brent crude was heading past $80 a barrel and reached its high for 2025, a smidgin under $84, in the second week of January. It trailed gradually lower all year, dipping below $60 in May before jumping in June before the US attack on Iran’s nuclear sites. By the end of the year it was hovering around $60.
Several factors have pushed it down. Projects that were delayed by the pandemic came onstream, notably Exxon’s Yellowtail offshore development in Guyana and a string of fields in the Gulf of Mexico. That was less important than the behaviour of the big oil-producing nations. Having cut production to support prices in the wake of Covid, last year they lost their discipline, pumping more to push up revenues. Opec+, the alliance that includes the 12 Opec countries plus ten other oil exporting nations, agreed to increase production in April and again in September. Last month, after spats about which members were keeping to their quotas, they agreed a new way to determine individual states’ production capacities — something that sounds trivial, but which oil experts think will lead to a wave of investment in new fields.
The end result is a lot of oil sitting waiting for a buyer, either on land or bobbing about in tankers. The International Energy Agency’s December oil market report said that by the end of October the amount of stored oil had reached eight billion barrels, the highest in four years, a stock that was then growing by 1.4 million barrels a day. The IEA noted, however, that even though there was a glut of oil, petrol and diesel prices had not fallen as fast as expected, something of which you are reminded when you fill up your car. A lack of refining capacity had created a “parallel market” where the price of oil was moving independently from the price of the products derived from it. The IEA said the situation could ease this year as refineries that were shut for maintenance came back online.
As a side note, this glut has built up even as demand for oil has grown — by 830,000 barrels a day last year, the IEA said, with a forecast for a slightly greater increase this year.
Donald Trump is at the centre of two Rumsfeldian “known unknowns” that could push prices down even further. He is aiming to unseat Nicolás Maduro, the ruler of Venezuela, the sleeping giant of the oil game. It has the world’s largest oil reserves: Opec’s annual statistical bulletin estimates 303 billion barrels, ahead of Saudi Arabia at 267 billion. Yet production has collapsed in the past three decades, from about three million barrels a day to below one million.
The second known unknown is Trump’s attempts to broker peace between Ukraine and Russia. It is hard to know what form a deal would take and whether it would allow the full return of Russian oil and gas to western markets. The European Union, in particular, might be reluctant to ease sanctions even if an agreement were cobbled together.
There is one other geopolitical unknown involving Trump, although less directly. Iran is in the grip of another round of violent anti-government protests. Again it is hard to predict the outcome, but it is worth remembering that Iran is third on that list of oil reserves. A sanctions-free regime would be a powerful new supplier to world markets.
If the oil price does tumble, prices of other goods will follow suit. That would be good news for UK inflation, which fell last year but which is still well above the Bank of England’s 2 per cent target. Oil has a less direct effect on our economy than in the past — manufacturing is now less than 10 per cent of GDP and the last oil-fired power station, Littlebrook D in Kent, closed a decade ago — but it is involved somewhere in the production of nearly everything we buy.
In the same year that Littlebrook shut, the economist Ian McCafferty, then a member of the Bank of England’s monetary policy committee (and a former head of macroeconomics at BP), gave a speech about the effect of the oil price on UK inflation. This was after another sharp fall in prices and McCafferty concluded the drop had been “the single most important factor in reducing … inflation”. It was some fall too. Inflation in December 2014 was just 0.5 per cent and 0.3 per cent the month after, requiring a letter from Mark Carney, who was then the Bank governor, to the chancellor explaining why he had strayed so far below target.
A similar fall would certainly be a boon to the chancellor. As McCafferty pointed out, however, predicting the effect of lower oil prices on UK growth is tricky. “While dearer oil typically encourages capital scrapping, cheaper oil does not necessarily lead to increased capital accumulation and greater productivity,” he said. Reeves will probably, though, count on some assistance from lower oil prices this year. She needs all she can get if she is to make good on her boast of confounding the OBR.
Dominic O’Connell is business presenter for Times Radio