What To Expect From Falling Oil Prices
by Robert Barone, (Ph.D., Economics, Georgetown University)
U.S. equity markets appear to be reacting as if there won’t be enough oil. The fact is, at least temporarily, there appears to be more supply than demand, even at prices more than 40% off their recent highs. As prices fall, the world will use more, and that will actually spur economic activity.
Markets Do Correct
Sometimes, markets just need to correct, and use a current event or trend as a triggering mechanism. But, bear markets in equities usually occur when recessions are approaching. There is no looming recession on the horizon, at least for the U.S. Labor markets are strong and tight. Industrial production is at record levels. Leading indicators are up; inflation is benign. Corporate profits are high. Holiday consumption appears buoyant, no doubt spurred by falling oil prices.
The Importance of Oil and Gas
Clearly, with falling prices, there will be some fallout in the oil and gas industry and its periphery. Some market commentators worry about the impact that such fallout will have on the economy, employment, and capital spending. No doubt some small drillers and marginal enterprises will be impacted, perhaps even file BK. Capital spending in the industry will fall precipitously, both in the U.S. and worldwide. (That seems to be the objective of OPEC in keeping production levels high.) So, it is critical to examine the importance of this industry to total economic activity.
In 2013, Gross Output (GO) was approximately $30 trillion. This measures all aspects of economic life and includes all B to B sales (not just value added or final output which is what GDP measures). For comparative purposes, 2013’s GDP was $16.8 trillion. Business spending represents about 52% of GO, Consumption 38%, and Government 10%. Looking at the Bureau of Economic Analysis’ Input/Output table for 2013, the Oil and Gas industry directly produced 2.0% of GO. In addition, other industries sold about 0.4% of GO to the oil and gas industry. So, while it is important, a recession in 2.4% of the economy isn’t going to stall the other 97.6%, especially when nearly every aspect of that 97.6% will directly benefit from lower oil prices.
Who Benefits from falling Oil Prices?
In the short-run, at least, a dramatic fall in the price of oil benefits consumers in most developed countries. No doubt, some countries that are export dependent on oil, will suffer. Middle East, Canada, Mexico, Venezuela, Russia, Brazil all come to mind. But, most of the rest of the world are oil importers and stand to benefit.
The U.S. consumer, in particular, will benefit from falling prices, as, of all major industrial countries, the U.S. is the most dependent on autos and trucks for transportation. For U.S. consumers, the fall in the price of oil is equivalent to a huge tax cut, or to a one-time rise in wages. Every penny of price decline at the pump is worth about $1.5 billion per year to U.S. consumers, according to Gluskin-Sheff’s David Rosenberg.
As of 12/12/14, according to AAA, the national average price of regular unleaded gas was $2.600. A year earlier, that price was $3.253 indicating that the price had fallen $0.653, or about 20%. Given that crude prices are down more than 40% over the past year, and likely headed lower, an equivalent fall in the price at the pump would put prices there at about $1.95, and would be worth about $200 billion to U.S. consumers, and is equivalent to a 1.5% rise in Disposable Income. It appears likely that pump prices will get to $1.50 in some parts of the country by spring, and if they average that level, American consumers will have received an injection of $260 billion. And that is just at the pump. Imagine the total benefit that all non-energy producing businesses will receive, from airlines and trucking to the pizza delivery service. Just think of a) expanding profit margins in these businesses and/or b) falling prices to consumers for those services. (I know the Fed doesn’t like falling prices, but if such prices fall because costs have gone down and profit margins have been maintained, then there is no reason for wages to fall, and the middle-class employee benefits from the falling price, even without a wage increase.)
Given such benefits, it is really hard to see how the issues in the oil and gas industry could tip the U.S. into recession. It is equally hard to see how the next 12 months’ growth rate in GDP won’t be 4% or better. How does this translate into equity market prices? “Buy the dips!”