Posted in Blog on 21 Jan 2016
There seems to be plenty of noise now about the potential for the global economy being derailed by low oil prices. It seems a big price to pay for a few care free months cruising about on a full tank petrol but somewhere deep down in the economics of it is a crisis.
It comes at a time when the legal sector is still demonstrating pretty good health. The number of practising Solicitors in England and Wales rose by 2% in 2015 to 132,245 according to figures released by the SRA. This is the highest ever year end figure.
So what’s driving it? Why are the world’s stock market getting the jitters about it? And what could be the impact on the legal sector?
Everybody wants to keep on pumping
Oil’s problem in a nutshell is of course supply and demand.
Weak demand from net consumer economies – those that import more oil than they produce. Established economies are not pushing on as expected and although Chinese demand may have initially taken up the slack that now seems to be falling away
Over supply. Probably the larger of the two problems but for one reason or another oil producers have got themselves in tailspin of epic proportions.
The success of fracking in the USA has reduced has reduced the country’s reliance on Middle East exports significantly - to the extent they are nudging close to being a net exporter. However fracking takes a lot more start up investment to get out of the ground so there is often a debt to service so companies cannot afford to stop pumping.
Oil and gas account for 70% of Russia’s revenues. It is not going to stop pumping because it needs the money to support its economy that is also under pressure from sanctions.
There is also a lack of cohesiveness amongst members of OPEC (a cartel of oil producing nations consisting of countries in the Middle East, Africa and South America). Saudi Arabia, the de facto leader of OPEC is the world’s largest oil exporter and has deep reserves but is reluctant to turn off the tap unilaterally. A depressed oil price is also considered by many to be a longer term Saudi strategy to see off the emerging US fracking threat. Venezuela on the other hand is in deep crisis with inflation running at 60% and on the brink of recession. Libya, Iran, Algeria and Nigeria need the oil price to be above $120 to balance their books domestically. Even the UAE need oil to be above $83 to support its public spending before it starts eating into its reserves. Everybody has a reason to keep on pumping. Oh and the icing on the cake is that Iran – free of sanctions - is just about to enter the fray.
The impact on the economy
Well for a while the sentiment was that cheaper oil would provide a boost to those economies that relied on the import of oil. Sectors that benefit include manufacturing, logistics and aviation. However observers believe we are going through a bitter sweet process – the warm feeling provided by the lower oil prices is soon going to evaporate as the money needed to fuel growth in economies dries up.
This is partly because a lot of the money for investment in the global economy originates from oil producing countries mainly through investment vehicles known as sovereign wealth funds. The largest is in fact Norwegian and is worth $824.9bn. Norway puts most of its oil revenues into the fund to prevent the economy from overheating and by law can tap into some element of the fund to plug any budget deficit. Its investments are diverse and include prime real estate in most of the world's major cities - it recently bought a chunk of Mayfair from the Crown Estate and owns the equivalent of 2% interest in the fortunes of the FTSE 100.
Sovereign wealth funds from the Middle East have also pursued a strategy of converting oil earnings into assets. The Qatar Investment Authority for example owns or has taken stakes in Harrods, Porsche, Tiffany and Co and many more luxury brands.
Sovereign wealth funds are not the source of all the world's investment capital but the fear is now that a fair chunk of liquidity is going to dry up. Oil producing countries are in the short term expected to be more focused on meeting domestic obligations - and in some cases supporting their regimes - rather than putting their money away for a rainy day.
Legal’s silver lining?
If you are still with me then thanks for sticking around.
I talked about that withdrawal of money to invest in business, property and brands. Well that alone is not going to be enough if we start to experience a prolonged period of depressed oil prices. Don't forget some oil producing economies have been running in the red for some time now so this is in fact their rainy day. Experts are now expecting sovereign funds to start disposing assets - some are even predicting a fire sale of sorts. The knock on effect should be a spike in corporate activity and residential and commercial property transactions. And that’s going to create plenty of work for the legal teams who are going to be involved on both sides of the transactions.
The spike could be exactly that. Medium to long term the oil price needs to be on a journey to repair itself in order for the flow of investment to reach the levels required to fuel growth and deal making in the global economy. The fortunes of legal pretty much tracked the last recession and recovery but hopefully measures will be taken to avoid a repeat. And how will you know? Well you won’t have to start reading the Financial Times to gauge the future health of the UK economy and the legal sector – just keep clocking the price at the pump every time you fill your car up.