We mentioned in this piece that one of the big factors in the British economy over the next year may well be the effects of the drop in oil prices. Since June last year, the price of Brent Crude has more than halved, and has recently fallen below $50 per barrel. Whilst this may be good news for anyone filling up their car, it is clearly not good news for oil producers or for the economies of oil-producing nations, especially those with a heavy reliance on the industry.
But it is not just the oil sector itself that suffers. Like all industries, the oil sector is interconnected with many other parts of the economy and so a long term decline in the price of oil will have a knock on effect elsewhere.
Before exploring this in more detail it is worth just giving a bit of background to the recent price plunge. Generally speaking, there seem to be three competing theories as to why the price has plummeted so dramatically:
1. One theory doing the rounds is that the dramatic fall in prices has its origins in geopolitics, rather than economics, and is the direct result of a collusion between the governments of Saudi Arabia and the US to increase production and so drop the price, in order to hurt the economies of nations such as Russia, Iran and Venezuela. In favour of this theory, it is certainly the case that these nations’ economies are suffering adversely due to the price plunge. For example, Venezuela, whose economy was already in difficulty, has been hit especially hard, with inflation now topping 60% and its credit rating recently cut by Moodys two places to Caa3, meaning “Default imminent with little prospect for recovery.”
2. A second theory, which is both economic and political, is that far from being a collusion between the US and Saudi governments, what is happening is rather an attempt by the OPEC countries to throttle the US shale oil and gas industries. In favour of this theory, it is clear that the price plunge is very much affecting the US shale industry, and this is seen by those favouring this theory as demonstrating that the first explanation is false.
3. The third theory, which is purely economic and far less sensational, is that the fall in oil prices is simply a result of international over-supply at a time when demand has fallen, at the same time as the dollar — the currency in which oil is priced — is over-inflated. In favour of this theory, over against the first two, it is said that lower oil prices are bound to have an adverse effect on all oil producing countries, and so why would any of them deliberately lower the price to the levels we are seeing if it hurts them as well?
Whatever the explanation, the plunge in prices is being felt all over the world and is now a real problem for Britain. For instance, according to Robin Allan, chairman of the independent explorers’ association Brindex, the North Sea oil industry is “close to collapse”. The somewhat depressing picture he painted at the end of last year is now being confirmed, for instance by the news earlier this week that Tullow Oil is set to announce job cuts in the next few weeks, followed by the news that BP is to cut 200 jobs and 100 contractor roles.
When assessing possible job losses, we might be tempted to look at the effects on the oil industry alone. However, as mentioned above, there is an interconnectedness between industries in an economy, which means that any cuts in the oil industry will have a knock on effect on other sectors. This may be obvious with regard to industries that have a direct connection with the oil industry — for example companies that supply equipment used on oil rigs — but in actual fact the effects are much broader than this. There are also another set of “induced effects”, whereby loss of earnings in one industry as jobs are cut affects industries outside the supply chain of that industry. For example, those working in the oil industry spend money in supermarkets and restaurants, etc, and so any job losses in the oil sector will affect these industries as well. In the case of the oil industry, because the earnings are well above the national average, job cuts within this sector are bound to have a significant effect even on some of these apparently unconnected industries, as we shall see in a moment.
So how can we find out what the knock on effects are likely to be? This is where Input-Output (I/O) modelling comes in. I/O is a technique that links the interdependencies between different sections of an economy, measuring the ripple effect of certain economic actions on the wider economy. So if X amount of jobs are added in the oil industry, this will result in Y number of jobs being created in other industries across the country. Conversely, if X number of jobs are lost in the oil industry, this will result in Y number of jobs being lost in other industries across the country. The I/O model sets out to find out the value of Y by applying a multiplier effect to the value X. For a more detailed look at how this works, click here.
At this stage, we do not yet know how many jobs might be lost in the oil industry, and so it is impossible to accurately assess how much effect the plunge in oil will have on the British economy. However, what we can do is to run an Input-Output model using a hypothetical number, in order to give some idea of the effect job losses in the oil industry might have on other sectors.
According to our data, there were 15,443 people employed in the Extraction of crude petroleum industry in 2014 with an average wage of £79,263 (please note there were also 22,929 people employed in the Support activities for petroleum and natural gas extraction sector, but for the purposes of this example we will just concentrate on the primary sector).
Although not crucial for the example we are running, it is worth looking at the types of jobs in the industry. By running a staffing pattern for Extraction of crude petroleum, we find out that there are 54 different job descriptions within the sector, with the 20 largest being as follows:
|Occupation||Employed in Industry (2014)||% of the Total Jobs in Industry (2014)|
|Production and process engineers||1,279||8.3%|
|Precision instrument makers and repairers||883||5.7%|
|Scaffolders, stagers and riggers||820||5.3%|
|Production managers and directors in mining and energy||696||4.5%|
|Engineering professionals n.e.c.||608||3.9%|
|IT user support technicians||473||3.1%|
|Human resource managers and directors||470||3.0%|
|Chemical and related process operatives||463||3.0%|
|Metal working production and maintenance fitters||394||2.5%|
|Business sales executives||384||2.5%|
|Design and development engineers||358||2.3%|
|Other administrative occupations n.e.c.||344||2.2%|
|Quarry workers and related operatives||320||2.1%|
Now let’s suppose that the industry as a whole were to shed 10% of the workforce in 2015. What would this mean? According to the I/O model, the Extraction of crude petroleum sector has a jobs multiplier of 25.73. In other words, for every job gained or lost in this industry, another 24.73 are gained or lost in various other industries. This is far above the average jobs multiplier for all other industries across the country, which works out as 5.58.
In terms of job numbers, what this means is that the loss of 10% of jobs in the sector — that is 1,554 jobs — would lead to a total job loss throughout the economy as a whole of something like 40,000 jobs. For a detailed breakdown of which other sectors would be most affected, there are further details here. (It is worth noting that although in this particular instance we are using the I/O model to forecast an essentially negative outlook, if the reverse were true and the oil sector was about to add 1,554 jobs, the knock on effect would be to create almost 40,000 jobs throughout the economy as a whole).
What this plainly shows is how important this industry is to the health of the British economy. So whilst we might drive into the forecourts with a smile on our face as we see prices far below what they were a year ago, in the long run it might turn out to be something of a double-edged sword.
For more details of how our Input/output model can help you assess the effects of job growth or decline in your region, click here or contact Andy Durman at email@example.com