Knock-on effects of the oil price plunge on other commodities

The halving of oil prices has led to an intense debate on its effect on export earnings of oil producing countries, global growth, inflation, and monetary policies. A less discussed issue relates to its effect on other commodity markets. This blog post argues that low oil prices will have knock-on effects on a number of other commodity prices, including natural gas, fertilizers, and food (you may also want to read my previous post on commodity cartels).

Natural gas. The decline in oil prices will likely translate into lower natural gas prices in Europe and liquefied natural gas (LNG) prices in Asia. LNG prices in Japan and natural gas prices in Europe have already declined more than 15 percent each from June 2014 to February 2015. If low oil prices persist, the price of LNG, mostly destined to Asian markets, will drop further given the tight linkages in pricing contracts. Low oil prices will also put downward pressure on European natural gas prices, since they are partly linked to oil prices. Prices in the United States will be affected less because they are determined by domestic supply and demand conditions.

Fertilizers. Natural gas is a key input in fertilizer (mostly nitrogen-based) production. Already, fertilizer prices are down (in February 2015) 30 percent since 2011 and more than 60 percent since their all-time highs of 2008. Following the post-2005 collapse of natural gas prices in the United States, due to the shale gas and oil boom, many fertilizer producers began moving their production plants to the United States in order to capitalize on the “energy premium”. This trend, however, may be reversed if low oil (and, hence, natural gas) prices persist.

Agriculture. Lower oil prices will also impact agriculture, which is 4-5 times more energy intensive than manufacturing, through several channels. Most importantly, falling fuel prices are expected to reduce production and transportation, including cost of chemicals and fertilizers, some of which are crude oil byproducts or directly made from natural gas. Lower oil prices could also reduce the opportunity cost of biofuel production. However, the declining attractiveness of biofuels production in an environment of low oil prices will likely be mitigated by current policies. Because most diversion of food commodities to biofuels is policy mandated, the increase in oil consumption triggered by low oil prices may, in fact, increase diversion of grains and oilseeds to the production of biofuels. Overall, the response of agricultural prices to a 1 percent decline in energy prices has been estimated around 0.11-0.25 percent. Based on these estimates, a 45 percent decline in oil prices could be associated with a 10 percent decline in the prices of agricultural commodities.

These changes in non-oil commodity prices will affect activity in many developing countries. Especially for low-income countries, because of heavy their dependence on agriculture, the link between oil and agricultural commodities has important growth and poverty implications. Developing countries, more generally, have large market shares for various other commodities and, conversely, many are heavily dependent on the exports of a few raw materials. The broad-based commodity price declines of 2013-14 have already helped improve current account deficits in many countries in East and South Asia but caused a significant deterioration of terms of trade for Latin American and Sub-Saharan African countries which export agricultural products and metals. Across Sub-Saharan Africa, a 30 percent decline across all commodity prices could reduce GDP by 0.5 percent, with commodity exporters being affected the most.

This post is based on the recently released World Bank Policy Research Note titled ‘The Great Plunge in Oil Prices: Causes, Consequences, and Policy Responses’. The Note builds on the analysis of oil markets, published in the January 2015 editions of the World Bank’s Global Economic Prospects and Commodity Markets Outlook.

This article originally appeared on The World Bank’s Prospects for Development Blog. Publication does not imply endorsement of views by the World Economic Forum.

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Author: John Baffes is a Senior Economist with the Development Prospects Group. 

Image: An attendant prepares to refuel a car at a petrol station. REUTERS/Max Rossi