Oil price fallout: Producers struggle as GDP grows

The price of a barrel of Brent crude dipped below $64 to a fresh five-year low this week as members of the world's largest crude oil producer cartel in the world forecast lower demand next year.

The Organization of Petroleum Exporting Countries cut its supply forecast to its lowest in over a decade, as U.S shale supplies surge and global demand remains sluggish.

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A gas flare is seen at an oil well site outside Williston, N.D.
Andrew Burton I Getty Images
A gas flare is seen at an oil well site outside Williston, N.D.

Bearish analysts have consistently cut price forecasts, with Bank of America predicting a slump to $50 per barrel in coming months as market forces shake out the weakest producers.

Longer term, most economists are convinced the oil price will ultimately stabilize, with price targets ranging from between $80 and $100.

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But for 2014 and even in the next two years, the outlook points to price weakness. Capital Economics lowered its end of-2015 forecast to $65 and our end-2016 forecast to $60 due to the fall in the cost of production for the shale industry.

CNBC takes a look at how falling oil markets have already had a severe impact on financial markets.

Oil producers face $1 trillion loss

Oil prices have fallen over 40 percent in the last six months, which means global oil producers have lost around $1.2 trillion over the span of a year as a result of the $35 drop in the price of a barrel of oil, according to chief economist at RBC Global Asset Management, Eric Lascelles.

"Daily production is 93 or so million barrels, so over the next year, from September to September, $1.2 trillion is being lost to producers and therefore consumers are also benefitting to that amount," Lascelles told CNBC.

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"OPEC, have seen such weak demand for their oil in part because there has been such innovations elsewhere that have eaten away some of their market share. The shale oil, the oil sands and others are eating OPEC's lunch," he said.

The demand for bonds

Analysts and experts sometimes argue that a lower oil price is a threat to U.S. government debt because oil exporters typically save a larger share of their income than oil importers and are more prone to put their savings into U.S. government bonds. Smaller income means lower demand for U.S. Treasurys.

But chief market economist at Capital Economics, John Higgins expects the Fed will tighten policy sooner and more aggressively than expected as the labor market improves.

"This view has also been central to our projection that the 10-year Treasury yield will climb to 4 percent by the end of 2016. The more the price of oil falls, the more confidence we have in these forecasts," Higgins said.

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Equally, a falling oil price tends to reduce bond yields in oil consumers, both because of declines in inflation and improving government finances, according to Oxford Economics.

In the case of further oil weakness, Oxford Economics' John Bulford predicts that declines in euro zone sovereign bonds will be "pronounced" in the euro zone, including the periphery.

"Declines are more substantial in emerging market oil consumers, because the impact on nominal GDP growth is larger there. Oil producers experience significant increases in nominal yields, the highest in Russia but also in Malaysia and Norway," he said.

For U.S. high yield debt, shale oil makes up around 17 percent of outstanding high yield bonds and shale oil producers are quite dependent on leverage and on credit to sustain their operations, according to Lascelles. If the price stays low – or falls even further – these producers will struggle to maintain their debts.

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"Depending how low oil goes, it is conceivable that some of those players could find themselves on default. There has been much speculation on what the default rate could be in the high yield space and worst case scenario I think you could have overall high default rates go from around 2 percent to around 4 percent, so a doubling of default rates," he added.

Growth rates

Most analysts agree that an extended period of lower oil prices should be positive for the global economy as a whole, particularly for key emerging economies such as China and India.

"As well as representing a substantial transfer from oil producers to consumers, who tend to spend more of their income, it will also help to keep inflation low and ease current account imbalances. However, we also see scope for renewed worries about the impact on the big losers, including geopolitically important economies like Russia, and on the oil industry itself," said Julian Jessop, chief global economist and director of Capital Economics.

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Norway's central bank cut interest rates in a surprise move on Thursday, to prop up the economy which was hit in part by weak oil prices.

The central bank cuts its benchmark rate to 1.25 percent from 1.5 percent, defying expectations for a steady rate and a promise of lower rates next year.

"As oil prices get lower, the prize to the fastest growing major economy goes to the Philippines, whose GDP (gross domestic product) growth would pick up to 7.6 percent on average over the next two years, were oil prices to slump as far as $40 per barrel," Bulford said.

At that price, Russia is at the bottom with growth slumping to minus 2.5 percent on average in the next two years, without incorporating Russia's other issues. In the extreme bear case of $20 per barrel, Norway is the biggest GDP loser, being 0.3 percent lower, he said.