People are now fearful of the term derivative, but its implications are worth applying to deduce the economic consequences of low oil prices after the current financial crisis.

A derivative literally means a variable that is drawn off from another variable.

With that in mind, I often apply it to a consideration of the consequences of a consequence. In the case of falling oil prices, the consequences of the consequence are what concern me.

Oil prices have been declining steadily over the past few months from a high of US$147 (HK$1,146.60) per barrel to the present US$50 level. In the short term, the economic consequences of this are encouraging.

The United States, which accounts for a quarter of the world's total oil demand, is getting some relief.

For example, petrol has fallen from US$4 a gallon to about US$2.30, translating to a roughly US$200 monthly savings for a two-car American household.

The same is true for natural gas, which will save Americans US$700 this winter, as prices have dropped from a recent high of US$13 per 1,000 cubic feet to around US$6.30.

With declining prices, inflationary pressure subsides. Governments can now cut interest rates more freely to stimulate the economy.

Moreover, low oil prices have narrowed America's trade deficit, indirectly easing another concern of this oil-importing nation.

As the world is now in recession, many economists are worried about deflation; thus, they conclude that oil and other commodity prices are not expected to rise in the near future.

At first glance, we should celebrate lower energy costs. However, the short- term benefits of lower costs only postpone the world's long-term energy concerns.

A recent report from Wood Mackenzie found that more than four out of five oil refinery construction projects since 2005 have faced cancellation or hold-ups due to falling oil prices.

These projects, which take two to seven years to complete, are essential to meet the future energy demand of the world.

According to the Energy Information Administration, the world's daily oil supply is 85.69 million barrels, and our daily consumption is 85.23 million barrels. With demand growth stalling next year due to the current economic turmoil, the world's already tight oil supply will take a breather.

That said, oil firms such as ConocoPhillips in the United States and Saudi Aramco in Saudi Arabia (the largest state-owned oil company in the world) are cutting budgets and reviewing their existing projects, as some have become unprofitable with oil trading around the US$50 level.

Low oil prices will suck the world into a vicious cycle in which short-term gains for consumers will lead to another year or two of under-investment in oil production capacity.

Thus, the longer oil prices stay at the current level, the greater the impact will be when the global economy returns to growth.

At that moment, we will learn how to take the derivative of a consequence the hard way.

* Ronald Chan is the founder and chief executive of Chartwell Capital, a private investment company.

e-mail: ronald@chartwell- capital.com.hk