To modify Benjamin Franklin, it seems that in Australia nothing can be said to be certain, except death, taxes and endless debate about property prices. Why is it so unaffordable? Are foreigners to blame? Is it a good investment? Is negative gearing the problem? Are property prices about to crash?

Worries about a property crash have been common since early last decade. In 2004, The Economist magazine described Australia as “America’s ugly sister” thanks in part to a “borrowing binge” and soaring property prices which had seen it become “another hotbed of irrational exuberance”. At the same time the OECD estimated Australian house prices were 51.8% overvalued. Since the GFC, predictions of an imminent property crash have become more common with talk that a property crash will also crash the banks and the economy.

Our view since around 2003 has been that overvaluation and high levels of household debt leave the housing market vulnerable. As such it could be seen as Australia’s Achilles heel. However, in the absence of a trigger it’s been hard to see a property crash as a base case. Not much has really changed. This note takes a look at the key issues and what it means for investors.

Overvalued, over loved and over indebted

The two basic problems with Australian housing are that it is expensive and household debt is high. Overvaluation is evident in numerous indicators:

  • According to the 2016 Demographia Housing Affordability Survey the median multiple of house prices in cities over 1 million people to household income is 6.4 times in Australia versus 3.7 in the US and 4.6 in the UK. In Sydney it’s 12.2 times and Melbourne is 9.7 times.
  • The ratios of house prices to incomes and rents are at the high end of OECD countries and have been since 2003.
  • Real house prices have been above trend since 2003.

Source: ABS, AMP Capital

The shift to overvaluation more than a decade ago went hand in hand with a surge in the ratio of household debt to income, which took Australia’s debt to income ratio from the low end of OECD countries to now being around the top.

Source: ABS, RBA, AMP Capital

Overvaluation and high household debt are central elements of claims that Australian house prices will crash. These concerns get magnified whenever there is a cyclical surge in prices as we have seen recently in Sydney and Melbourne.

But a crash seems elusive

However, given the regularity with which crash calls for Australian property have been made over the last decade and their failure to eventuate, it’s clear it’s not as simple as it looks.

First, the main reason for the persistent "overvaluation" of Australian home prices relative to other countries is constrained supply. Until recently Australia had a chronic under supply of over 100,000 dwellings, as can be seen in the next chart that tracks housing completions versus underlying demand. Completions are at record levels but they are just catching up with the undersupply of prior years.

Source: ABS, AMP Capital

Consistent with this, vacancy rates while rising are below past cycle highs. In fact, in Sydney they are still quite low.

Source: Real Estate Institute of Australia, AMP Capital

Secondly, Australia has not seen anything like the deterioration in lending standards other countries saw prior to the GFC. There has been no growth in so-called low doc and sub-prime loans which were central to the US housing crisis. In fact in recent years there has been a decline in low doc loans and a reduction in loans with high loan to valuation ratios. See the next chart. And much of the increase in debt has gone to older, wealthier Australians, who are better able to service their loans.

Source: APRA, AMP Capital

Third, and related to this, there are no significant signs of mortgage stress. Debt interest payments relative to income are low thanks to low interest rates. See the next chart.

Source: RBA, AMP Capital

By contrast in the US prior to the GFC interest rates were starting to rise. Yet in Australia bad debts and arrears are low. While new loan sizes have increased, Australians seem focussed on cutting their debt once they get it.

Finally, while some seem to think that because property prices in mining towns like Karatha are now crashing this is a sign that other cities will follow. This is non-sensensical. Property prices in mining towns surged thanks to a population influx that flowed from the mining boom. This is now reversing. Perth and Darwin are also being affected by this but to a less degree. By contrast the surge in property prices in cities like Sydney and Melbourne that occurred into early last decade predated the mining boom and their latest gains largely occurred because the end of the mining boom allowed lower interest rates.

The current state of play

Our assessment is that the boom in Sydney and Melbourne is slowing thanks in large part to APRA’s measures to slow lending to property investors. However, house price growth is likely to remain positive this year. Price growth is likely to remain negative in Perth and Darwin as the mining boom continues to unwind. Hobart & Adelaide are likely to see continued moderate property growth, but Brisbane may pick up a bit. Nationwide price falls are unlikely until the RBA starts to raise interest rates and this is unlikely before 2017. And then in the absence of a recession or rapid interest rate hikes price falls are more likely to be 5-10% as was seen in the 2009 and 2011 down cycles rather than anything worse.

Source: CoreLogic RP Data, AMP Capital

What to watch for a property crash?

To see a property crash – say a 20% average fall or more – we probably need to see one or more of the following:

  • A recession – much higher unemployment could clearly cause debt servicing problems. At this stage a recession looks unlikely though.
  • A surge in interest rates – but the RBA is not stupid; it knows households are now more sensitive to higher rates.
  • Property oversupply – this is a risk but would require the current construction boom to continue for several years.

Implications for investors

There are several implications for investors:

  • While housing has a long term role to play in investment portfolios it is looking somewhat less attractive as a medium term investment. It is expensive, offers very low income (rental) yields compared to all other assets except bank deposits and Government bonds and it’s vulnerable to possible changes to taxation arrangements around property.
  • There are pockets of value, eg in regional areas. You just have to look for them.
  • As Australians already have a high exposure to residential property (directly and via bank shares and property trusts), there is a case to maintain a decent exposure to say unhedged global shares because it could provide an offset if it turns out I am wrong and the Australian property market does have a crash.

 

Elizabeth Savage, University of Technology Sydney

Health Minister Sussan Ley today announced private health insurance premiums will increase by an average of 5.6% from April. This amounts to the average family paying about $300 more a year for an average policy.

This year’s increase is a little lower than increases of about 6% approved over the last two years.

The 2016 increases range from 3.8% for the Doctor’s Health Fund, to just under 9% for CUA health Fund. Increases for the largest funds, Medibank and BUPA, are just below the industry average. (Scroll to access the full list below).

Under the Private Health Insurance Act, the health minister must approve company requests for premium changes, unless she is satisfied that to do so would be contrary to the public interest.

After receiving the first round of applications, the minister requested on January 30 that health funds “resubmit lower applications for premium increases or provide any evidence of extenuating circumstances”. Twenty funds subsequently lowered their requests.

The minister’s request for funds to work with the health department to reduce premiums, while unusual, is not surprising. Since 1997, when the Howard government introduced the 30% health insurance premium rebate, the federal government is a significant stakeholder in the private health sector.

The annual cost of the premium rebate has grown markedly from about A$1 billion in 1998 to about A$6 billion currently.

In the 12 months to December 2015, the national regulator, the Australian Prudential Regulation Authority, reports that premium revenue increased by 6.9%, benefits paid by insurers by 6% and fund profits before tax by 7%.

Despite the small reduction in this year’s premium increase, the 2016 outcomes for the industry are unlikely to differ much from those of 2015.

What’s driving premium increases?

The major driver of premiums is the level of benefits paid to insured patients for hospital treatment and services covered by general insurance.

In 2015, total hospital benefits were A$13.58 billion, including A$2.13 billion for benefits to medical practitioners and A$1.95 billion for prostheses such as pacemakers, stents and artificial hips and knees.

Benefits for general cover (99% of which are for extras treatment such as dental, optical, chiropractic, natural therapies) totalled A$4.63 billion.

Hospital benefits have increased at a faster rate than extras. This is despite the share of the population with hospital cover remaining steady at around 46% to 47% over the past five years and very limited increase in the average age of the population with hospital cover.

Even though there has been a steady increase in the share of the population with general cover (from about 52% in 2010 to 56% in 2015) premium increases are being driven by hospital benefits, of which 14.4% are for prostheses.

Insurers could use higher benefits payments to justify premium increases if there was sufficient competition in the insurance sector to promote efficiency and lower costs of private treatment.

But the Australian industry is highly concentrated. The two largest insurers, Medibank and BUPA, have 56% of the market. This suggests that inefficiency is driving premium inflation, some of it arising from a poorly designed regulatory framework.

Benefits for prostheses

In 2015, insurers paid almost A$2 billion in hospital benefits for prostheses.

The insurance cost of prostheses was raised in a submission to the Harper Competition Policy Review from Applied Medical, a manufacturer of a clip applier used in laparoscopic surgery.

The submission argued that the minimum benefits set by the government regulator, the Prostheses Listing Authority, were far higher than both prices in comparable overseas countries and those paid by public sector hospitals in Australia:

Subject to the need to consult with stakeholders, there is sufficient power to implement reforms which would bring prostheses costs to the private health system down so that they would be comparable with prices paid in other countries – reducing prices by as much as 75%.

Applied Medical estimated that hospital benefits could be reduced by about A$600 million annually if excess benefits, currently shared between the manufacturer and the private hospitals, were eliminated.

The final report of the Harper Review, released in March 2015, recommended:

The regulation of prostheses should be examined to see if pricing and supply can be made more competitive, while maintaining the policy aims of the current prostheses arrangements.

Minister Ley has raised prostheses reform as a priority this year, noting that insurers pay $26,000 more for a pacemaker for a private patient than a public patient ($43,000 compared with $17,000).

What needs to be done?

According to an online government survey in November and December of 2015, the public is concerned about the affordability of health insurance and questions its value for money.

Despite premiums continuing to increase at a rate considerably above inflation, there is little evidence that people are responding by dropping their cover.

The Lifetime Health Policy, introduced the Howard government introduced in 2000, ensured that the penalties of doing so are too high if they wish to buy insurance at some time in the future. After the age of 31, the policy adds adds a 2% loading to the premium for every year of age over 30.

One way to keep premiums down is to address regulatory failures. Reforming the inflated prostheses benefits set by the government regulator and health minister in 2006 is in urgent need of attention.

Without such reforms, patients remain worse off, paying insurance premiums which increase every year. And the federal government is faced with an ever growing cost of the insurance rebate.

Another way is for government to rethink the incentives for insurers to pursue cost reductions by health providers that will lower insurance payouts and thereby lower premiums.

In the Australian system, insurers pay the providers agreed amounts and request approval from the minister for premium increases to cover increased benefit payouts. In other countries, insurers contract with specified health providers who compete both on quality and price for patients listed with the insurer.

Encouraging insurers to be more active could reduce premiums for consumers.

The Conversation

Elizabeth Savage, Professor of Health Economics, University of Technology Sydney

This article was originally published on The Conversation. Read the original article.

Monday, 29 February 2016 12:23

ASX 2 day settlement begins

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The settlement period for Australian sharemarket trades will be shortened by one day. Settlement
of your trade will be required to occur two business days after the day a trade takes place.
This settlement period will be called T+2 (trade date plus 2 business days). The change to T+2
settlement is proposed to take place for trades conducted on or after Monday 7 March 2016, with
the date to be confirmed by ASX.


This change will affect all financial products traded on a securities market1 in Australia, including
shares, units, bonds, hybrids, CDIs, exchange-traded Australian Government Bonds, exchangetraded
products (including exchange-traded funds), warrants and instalments.

 

To download the ASX explanatory note (259kb) click on the icon below.

 

Thursday, 25 February 2016 12:10

RBA on hold - policy debate in US a key

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BillEvans small headshot WIBIQThe Reserve Bank Board next meets on March 1. We are confident that the Board will decide to keep rates on hold.

The Governor has made it clear that the Bank will be most closely monitoring progress in the labour market and whether there is any evidence of the recent turmoil in financial markets impacting domestic demand in Australia.

In that regard time will be required to get a clear read on those developments. Markets remain reasonably confident that the necessary information will be available by May with market pricing implying around a 60% probability of a rate cut by then.

We remain comfortable with our long held view that rates will remain on hold throughout 2016.

We were not particularly concerned about the lift in the unemployment rate from 5.8% to 6.0% given that the move was consistent with our forecast that unemployment would edge up to around 6%. That forecast has been contrary to the Bank’s forecast that the unemployment rate would continue to fall through 2016. However we do not expect that the RBA to be too perturbed by the result given the month to month volatility and that ‘trend’ unemployment rate estimates continue to track lower.

Evidence around the impact of the financial turmoil on domestic demand will not be clear for some time. Early evidence around consumer sentiment (up 3.5% in February) and business conditions (stable in February) is not pointing to significant signs of any fallout.

Of course the path of the Australia dollar will also be a key input to the board’s deliberations over the course of the next few months. In that regard the path of the US dollar and US monetary policy will be key factors.

Over the last week I have been travelling in the US meeting with policy officials; real money managers; hedge funds and economists.

Some key themes around US monetary policy; the US dollar; and the state of the US economy have become clear.

The starting point is current market pricing. With virtually no FED hikes priced in for the remainder of the year our current call for three hikes by year’s end looks decidedly ‘courageous’. However that needs to be put in the context of a category of views expecting the FED to be reversing its December rate hike and moving rates into negative. Those low end expectations are skewing market pricing and masking the forecasts of other participants who are expecting a series of FED moves over the course of 2016.

The areas of serious debate are around the US’s current potential growth rate. With very weak productivity growth; growth in the working age population having slowed; and the participation rate weak, even allowing for improving demographics, estimates of potential growth in the US are stuck in the 1.3–1.7% range.

General forecasts for growth in 2016 are around 2%, almost exclusively because of the boost in spending from consumers as strong employment growth boosts incomes and households decide to spend more of the windfall from falls in the oil price (current estimates are that only around 50% of windfall has been spent). Little hope is held out for postive growth contributions from government, inventory accumulation or investment while net exports can be expected to remain a drag.

However, if growth does exceed potential then further falls in the unemployment rate can be expected. Concerns around a sudden lift in wage pressures (which are already building) once the unemployment rate reaches, say, 4.5% are held in many quarters (the debate around the actual level of the NAIRU is lively). Lags between wages and inflation are estimated at around six months making the FED’s inflation target of 2% easily achievable and even posing a potential need to lift the Fed funds rate. This scenario is clearly the key risk to current market pricing.

Evidence is cited that in US states where the unemployment rate has fallen below 4.5% wages growth has reached 3–4%.

This indicates that the link between wages and the unemployment rate still holds although at levels of the unemployment rate that are well below what had previously been expected to be the trigger point. It was further speculated that the lift in wages growth might be non-linear.

On the other hand there is clearly discomfort with the elevated level of the USD (considered to be the most important source of tightening financial conditions). Official research points to the impact on the US economy of the US dollar having long lags (it is notable that since the Fed raised the federal funds rate in December the US dollar index has fallen somewhat). The impact on growth of the 25% lift in the USD over the last two years is still to fully work through the economy. Resumption of the FED’s tightening cycle by June might risk a further substantial lift in the USD, intensifying the drag on the economy.

Earlier periods of USD strength have been associated with much stronger growth particularly due to strong productivity so a 0.5% drag from exports is much more significant when potential growth is 1.3%–1.7% than when it is above 3%.

Resolution of this policy dilemma will play out over the next six months or so. It may take policy makers longer than June to assess the US dollar effect on the one hand and the risks to wage inflation on the other.

Our current view is that the authorities will tread a middle ground. Policy will need to be tightened in anticipation of potential wage pressures but will be focussed on avoiding a USD lift through 2016 of more than 8–10%. Clearly the key variables to watch are jobs growth; the unemployment rate; wage pressures and of course the path of the USD.

 

Bill Evans - Westpac Chief Economist

Thursday, 25 February 2016 12:00

Contagion is unlikely for the banks

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The banks have taken a beating lately, with the financials ex-property subindex falling 27% for the year to date. One of the big fears for investors has been the banks exposure to commodities, oil and gas lending. However, Uday Cheruvu thinks that their exposure is ‘very manageable’ as the banks only have around 3-6% exposure to these sectors on average. The exposure that the banks do have is mostly to well-established players, with very limited exposure to high-yield lending. “Maybe there is a risk, but the size of the risk is significantly smaller than what people are worried about,” he said. Indeed, leading into the GFC, banks had up to 30% exposure to sub-prime loans, whereas total exposure to oil & gas high-yield lending is closer to 2%. Given the limited exposure, he says contagion in the financial system is unlikely.


This video courtesy of PM Capital is well worth watching.

 

Michelle Grattan, University of Canberra

The government is set to secure reforms to the Senate voting system that will squeeze out “micro”-players.

Immediately after the changes were announced by Prime Minister Malcolm Turnbull and Special Minister of State Mathias Cormann, the Greens welcomed the move and called on the ALP to support it.

While the Greens said they would scrutinise the legislation, which was introduced in the House of Representatives immediately after the announcement, they have had extensive negotiations with the government. Support from the Greens is all that is needed to get the measures through the Senate.

The changes would bring in optional preferential voting “above the line”, replacing the present group voting tickets. Voters would be advised to number at least six boxes in order of choice. But their vote would still be valid if they numbered only one box.

At present, people just mark one box but have no control over their preferences. Complicated deals over preferences have meant the election of candidates on tiny votes.

Almost all voters vote above the line.

In relation to below-the-line voting, the government proposes to reduce the number of informal votes by increasing the number of mistakes allowed from three to five, as long as 90% of the voting paper is filled in correctly.

Group and individual voting tickets will be abolished.

A restriction will be introduced to prevent individuals holding relevant official positions in multiple parties.

The changes also allow parties, if they wish, to have their logos on the ballot paper, to reduce confusion. At the last election the Liberals complained that many of their voters thought the Liberal Democratic Party (LDP) was the Liberal Party. The LDP got senator David Leyonhjelm elected in NSW.

Turnbull said there had been much criticism of the last Senate election. People were astonished to see senators elected on very small votes. Under the reforms every Australian who voted in the Senate “will determine where their vote goes. And that’s democracy”, he said.

If there is a double dissolution all or almost all micro-players would be immediately out. A normal election would make it nearly impossible for new micro-players, but the several elected in 2013 would still have more than half of their term remaining.

Amid speculation about a double dissolution, Turnbull said “nothing has changed”. He was working on the assumption that the election would be held at the normal time – which was August, September or October.

Turnbull said the government did not have a view on who would be electoral winners out of the change. He pointed out that the reform was recommended unanimously by the Joint Standing Committee on Electoral Matters.

That committee will now scrutinise the legislation, which the government wants passed by the time parliament rises for the autumn recess in mid-March. It will take the Electoral Commission about three months to make the necessary changes, which means they could be ready for either a normal election or a July double dissolution.

Greens leader Richard Di Natale said the Greens had been putting forward legislation over 12 years for Senate voting reform that ended backroom preference deals and put power back into the hands of voters.

“The only people who support the current system are the faceless men and factional operators who can wield power and influence in back rooms,” he said.

Independent senator Nick Xenophon, who won almost two quotas at the last election, supports Senate voting reform.

Labor, despite supporting reforms on the parliamentary committee, has since become sharply divided. Some factional heavyweights strongly oppose them, believing they would work to the Coalition’s advantage. Opposition Leader Bill Shorten reserved Labor’s position.

Motoring Enthusiast Party Senator Ricky Muir, elected in 2013 on about 0.5% of the Victorian Senate vote, tweeted his disapproval of Turnbull’s move.

Michelle Grattan, Professorial Fellow, University of Canberra

This article was originally published on The Conversation. Read the original article.

Wednesday, 10 February 2016 19:23

Magellan Global Update - 1st Quarter 2016

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Hamish Douglass (CEO Magellan Financial Group) talks about his current views on Global Financial markets.

He talks about the next steps in the US with the Quantative Easing program, China and how he has his fund positioned.

 

As one of Australia's leading investors - Hamish is very much worth paying attention to.

 

 

Tuesday, 09 February 2016 20:19

Apple AC adapter recall (important information)

Written by

Apple has determined that, in very rare cases, the two prong Apple AC wall plug adapters designed for use in Continental Europe, Australia, New Zealand, Korea, Argentina and Brazil may break and create a risk of electrical shock if touched. These wall plug adapters shipped from 2003 to 2015 with Mac and certain iOS devices, and were also included in the Apple World Travel Adapter Kit.

Customer safety is always Apple's top priority, and we have voluntarily decided to exchange affected wall plug adapters with a new, redesigned adapter, free of charge. We encourage customers to exchange any affected parts using the process below.

Note: Other wall plug adapters, including those designed for Canada, China, Hong Kong, Japan, United Kingdom, and United States and Apple USB power adapters are not affected by this program.

Identifying your wall plug adapter

Compare your adapter to the images below. An affected wall plug adapter has 4 or 5 characters or no characters on the inside slot where it attaches to an Apple power adapter. Redesigned adapters have a 3-letter regional code in the slot (EUR, KOR, AUS, ARG or BRA).

Affected Redesigned
Affected adapter detail Redesigned adapter detail


Affected Adapter Prong Types

European Adapter Korean Adapter Australian/Argentinian Adapter Brazilian Adapter
Round thin pins,
slightly slanted inward
Round thick pins Flat angled blades Round thin pins
Continental Europe Korea Australia
New Zealand
Argentina
Brazil

Note: The countries and regions listed are some examples of supported locations for that adapter. Adapters may be used in additional countries.

 

Exchange Process

Please choose one of the following options below. We will need to verify your Mac, iPad, iPhone or iPod serial number as part of the exchange process so please find your serial number in advance. Finding your device serial number is easy.

 

GEM Capital has replaced our affected AC adapters through our friends at the Computer Depot (Unley Road, Unley)  Ph 8357 7111 http://www.computerdepot.com.au

Mark Cunningham from the Computer Depot is happy to exchange Apple AC Adapters without the need to provide serial nunbers - and while you are there check out the latest technology that is available (both Apple and Microsoft).

 

Additional Information

This program does not affect your statutory or warranty rights.

If you believe you have paid for a replacement due to this issue, regarding a refund.

Learn more about using Apple power adapters, cables, and duckheads with Apple products.

Tuesday, 09 February 2016 20:07

The plunging oil price - why and what it means?

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Investment research glassesIntroduction

Our view on the financial market turmoil has been covered in the last two Oliver’s Insights - except to add that central banks are now sounding more dovish. This started with the ECB which is now expected to ease at its March meeting and is also evident from the Fed which last night was less positive on the growth outlook and indicated it was monitoring recent economic and financial developments. The probability of a March Fed hike is now just 20% and rather than four Fed rate hikes this year I see only one or none. The Reserve Bank of NZ has also turned more dovish and I expect the RBA to do the same.

The one big surprise in the ongoing turmoil in financial markets is the role played by oil. Past experience tells us surging oil prices are bad and plunging oil prices are good. But that has not been the experience lately. It seems there is a positive correlation been oil prices and share markets (“shares down on global growth worries as oil plunges” with occasional “shares up as oil rallies as growth fears ease”). So what’s going on?

Why the oil price plunge?

The oil price has collapsed because the global supply of oil has surged relative to demand. Last decade saw the price of oil go from $US10/barrel in 1998 to $US145 in 2008. After a brief plunge during the GFC it average around $US100 into 2014.

Black lines show long term bull & bear phases. Source: Bloomberg, AMP Capital

This sharp rise in the oil price last decade encouraged fuel efficiencies (use of ethanol, electric cars, etc) and more importantly encouraged the development of new sources of oil (offshore, US shale oil, etc) that were previously uneconomic.

Source: Bloomberg, AMP Capital

This is similar to what occurred in response to sharp rises in oil prices in the 1970s. But other factors are playing a role too:

  • Slowing emerging world growth. Chinese economic growth has slowed to around 7% compared to 10% or so last decade and more of this is now being accounted for by services and consumption so it’s less energy intensive.
  • Middle East politics – Iran coming back on stream this year and OPEC no longer functioning as a cartel but rather driven by Saudi Arabia’s desires to put pressure on Iran and assure its long term oil market share (by squeezing alternative suppliers and slowing the switch to alternative/more efficient energy sources).
  • Technological innovation has enabled some producers to maintain production despite the sharp fall in oil prices.
  • A rise in the $US, which has weighed on most commodities as they are priced in US dollars. However, the oil price has also plunged in euros, Yen and the $A.

Last year the world produced a near record 96.3 million barrels of oil a day, which was 1.8m more than was used. More broadly oil is just part of the commodity complex with all major industrial commodities seeing sharp price falls over the last few years.

Are we near the bottom for the oil price?

How much further the oil price falls is really anyone’s guess. Oddly enough having fallen 77% from its 2011 high the plunge is similar to past falls after which supply started to be cut back (see the next chart). I suspect we have now reached or are close to the point where, baring a global recession, it will start to become self-limiting but the oil price could still push down to $US20/barrel which in today’s prices marked the lows in 1986 and 1998.

Source: Bloomberg, AMP Capital

At current levels, even oil futures prices are likely below the level necessary – thought to be around $US50/barrel – to justify new shale oil drilling in the US. And prices at these levels are seeing consumer demand in the US shift back to more gas guzzling vehicles. So I suspect we are near the bottom. By the same token the ease with which shale oil production can be brought back on stream and rapid technological innovation in alternatives suggests a cap is likely to be in place on oil prices during the next secular upswing (maybe around $US60).

Why has the oil prices plunge been a big negative?

There are several reasons why the negatives may have predominated this time around. First, Middle East oil producers consume more of their oil revenues now than in the past and so a collapse in the latter may have forced a cutback in their spending compared to oil price plunges of the 1980s & 1990s.

Second, consumers in developed countries are more cautious than in the past & so respond less to lower energy costs.

Third, the plunge in oil prices at the same time the US dollar has increased has added to the stress in many emerging countries, causing funding problems in such countries and raising fears of a default event in the emerging world.

Finally, much recent corporate borrowing in the US and growth in investment has come from energy companies developing shale oil. They are now under pressure leading to worries of a default event and causing a fall back in investment.

But will the negative impact continue to predominate?

Many of these worries will persist but at some point the positive impact flowing from reduced business and consumer costs will become evident. The historical relationship indicates that the positive impact of lower oil prices and developed country growth takes a while to flow through, with the next chart suggesting the bulk of it is likely to show up this year.

Source: Deutsche Bank, Thomson Reuters, AMP Capital

Lower oil and energy prices also mean a usually one-off hit to inflation as the oil price level falls. This largely impacts headline inflation and is generally thought to be temporary. But the longer it persists the greater the chance that it will flow through to underlying inflation and inflation expectations. This is something that central banks are now grappling with as it makes it harder for them to get inflation back to their target levels, which in turn will mean low interest rates for longer.

What are the implications for Australia?

While Australia is a net oil importer, it is a net energy exporter which means that to the extent that lower oil prices flow through to oil and gas prices it means a loss of national income and tax revenue. For Australian households though lower oil prices mean big savings. The plunge in the global oil price adjusted for moves in the Australian dollar indicates average petrol prices should be around $0.90/litre (see next chart). While prices haven’t dropped this far – apparently due to high refinery margins based on Singapore petroleum prices – the price at the bowser is still well down on 2014 levels.

Source: Bloomberg, AMP Capital

Current levels for the average petrol price of around $1.10/litre represent a saving for the average family petrol budget of around $14 a week compared to two years ago, which is a saving of $750 a year. Some of this saving will likely be spent.

Source: AMP Capital

What happened to “peak oil”?

Last decade there was much talk of an imminent “peak” in global oil production based on the work of Dr M. King Hubbert and that when it occurs it will cause all sorts of calamities ranging from economic chaos to “war, starvation, economic recession and possibly even the extinction of homo sapiens”. The film “A Crude Awakening” helped popularise such fears. Such claims have in fact been common since the 1970s, but they have been wide of the mark with global oil production continuing to trend higher. With the real oil price once again plumbing the lows of the 1980s and 1990s it’s clear that such claims remain way off. While the world’s oil supply is limited, “peak oil” claims ignore basic economics which, via higher prices combined with new technologies, will make alternatives viable long before we run out of oil.

Implications for investors

As long as the oil price remains in steep decline the negative impact on producers is likely to predominate the positive impact on consumers at least as far as share markets are concerned. However at some point in the year ahead, it’s likely the boost to consumers and to economic growth in developed countries and in energy importing countries in Asia will predominate. In the meantime weak oil prices mean that deflationary risks remain and interest rates will remain low for longer.

About the Author

Dr Shane Oliver, Head of Investment Strategy and Economics and Chief Economist at AMP Capital is responsible for AMP Capital's diversified investment funds. He also provides economic forecasts and analysis of key variables and issues affecting, or likely to affect, all asset markets.

The turbulence in financial markets would appear to suggest that the world is heading toward recession.  Leading investment bank have produced a table showing the probability for major countries of recession over the next 8 quarters (2 years).  The table suggests that Australia's chances of recession in the next two years is 21%, which is below the long term average.