One of the more interesting parts of the downturn has been what, if any, effect low oil have had on the U.S. economy. On October 01, 2014, WTI closed the day at $90.73. By January 2, 2015, oil was pricing at $52.27. From October 01, 2014 until September 28, 2016, oil reached a low of $26.05, averaged $49.09 and was down $66.91 (-%49.33).
Historically, low oil prices have had a positive effect on the U.S. economy. Such venerable names as Moody Analytics were quick to argue that low oil prices are a boon to the U.S. economy. Here is just one such quote explaining why, historically, low oil prices are so beneficial:
Numerous crosscurrents must be considered when calculating the effect of oil price declines on the prospects of the U.S. economy. Oil price declines act as a tax cut, enabling consumers to spend a greater percentage of their incomes on nonenergy goods and services. Every 1-cent decline per gallon in gasoline prices frees up $1.1 billion in spending over the course of a year. If the $60 decline in oil prices is sustained over the course of a year, lower oil prices would free up $165 billion for nongasoline expenditures. Households would also benefit from lower heating oil and diesel prices, freeing up an additional $50 billion. Furthermore, since the U.S. is still a net oil importer, lower oil prices reduce the nation’s trade deficit…the extent to which lower oil prices help the economy to expand depends on the decline in inflation, which amplifies real spending and creates jobs, and the increase in corporate profits. Higher real spending prompts businesses to increase investment and hire more workers. Businesses also benefit from lower input costs and thus higher profit margins, especially those for which oil is a major input cost. These include transportation, agriculture and manufacturing companies. https://www.economy.com/home/products/samples/2014-01-14-Economics-of-Lower-Oil-Prices.pdf
Moody’s does go on to explain that lower oil prices hurt U.S. drillers thereby reducing CAPEX for new development and result in layoffs. However, they conclude:
On net, though, lower oil prices are an unambiguous positive for the U.S. economy. Even when accounting for the indirect jobs tied to the energy industry, two jobs will be created in nonenergy industries for every energy-linked job that is lost. Corporate profits also get a net boost, although the positives are diffused among a greater number of businesses than the negatives. Because of the preeminent effect of lower inflation in the lower oil price equation, each $10 decline in oil prices boosts U.S. real GDP growth by 0.15 to 0.2 percentage point per year. If oil prices come in as expected this year, real GDP growth would be boosted by 0.5 percentage point.
Please understand, I am certainly not picking on Moody’s here. There are very smart folks that write these opinions. And their opinions are in line with traditional economic reasoning. Before the downturn, most economists would have concurred wholeheartedly with Moody’s and stated emphatically that theoretically and historically lower oil prices are good for the U.S. economy as a whole.
And that, in part is what creates the boom/bust cycle in oil. Historically, low oil prices result in the simultaneous cut of CAPEX expenses and an increase in demand because of the economic growth caused by low oil prices. Eventually, demand then outstrips supply, and supply is slow to recover resulting in the boom before the crash. And then, inevitably, a crash.
A thorough analysis of all of these issues was conducted by the Brookings Institute in their awesome 53 page report is available at https://www.brookings.edu/wp-content/uploads/2016/09/5_baumeisterkilian.pdf. Let me save you some time and lots of reading to cut down to the highlights:
Despite stellar predications at the beginning of the downturn, average U.S. real economic growth has increased only slightly since 2014Q2 from 1.8% to 2.2%. (Note: under the traditional model, it should have easily been double that number).
Some Sectors did well. In particular, candy and soda (+7%), beer and liquor (+10%), and tobacco (+16%) do well, perhaps because such goods are sold at gas stations, but also food products (+7%), and apparel (+11%). Both tourism (+11%) and restaurants, hotels and motels (+8%) benefited from lower oil prices, as consumer demand rose. So did retail sales (+14%). Amazon (+38%) and Home Depot (+32%) did particularly well. Only recreation, entertainment services, and publishing did not partake in this boom.
The petroleum and natural gas sector (-28%), unsurprisingly, was hit hard. Within that sector, refining companies that use crude oil as a production input fared somewhat better. Other industries that rely on oil as a major input and hence would have been expected to profit from lower oil prices such as rubber and plastics (+4%) and logistics (+2%) did not benefit much, and chemicals (-6%) actually performed worse than the overall market, arguing against an important supply (or cost) channel of transmission. Airlines (+15%) benefited both from lower fuel costs and higher travel demand. Likewise, textiles were helped by lower input costs and higher demand (+13%). The surprising fact that auto companies performed below average (-9%) is largely explained by weak foreign sales, reflecting the recent global economic slowdown. Sectors tied to commodity markets such as agriculture (-12%) or mining (-31%) performed poorly for the same reason. Steel (-26%), fabricated metal products (-51%), machinery (-19%), and ship building and railroad equipment (-13%), all suffered from lower demand, in part from the declining oil sector and in part due to the decrease in global real economic activity.
Other key highlights from the report (please note these are almost direct quotes in most cases and I have added emphasis for you):
The bottom line is that while the U.S. economy did not truly contract as a result of low oil prices, it did not grow by near the predicted levels, thus indicating the increased importance of oil and gas, and the industries that service it, to the American economy.
First, it is worth pointing out that oil and gas has been the fastest growing sector in the U.S. economy for about a decade – meaning that anything causing investment to stall and employment to be slashed will have a negative impact, at least in the short term. It is theorized capital spending by oil and gas producers increased at a compound annual rate of around 16% between 2002 and 2012. Indeed, Oil and gas producers accounted for almost $1 in every $8 of new business investment in the U.S. economy in 2013, according to data published by the Census Bureau – which equates to approximately 14% of all new capital expenditures in the U.S. for that year. Compare that to a measly 2.7% increase per year for the rest of the business capital spending.
And, of course, the problem is job loss. Unlike our new consumer driven economy (think about your friendly McDonald’s personnel), oil and gas jobs are high paying. Average wages in the oil and gas extraction sector, at nearly $160,000 in 2013, were almost three-times the private sector average, according to the Bureau of Economic Analysis. Even in the support sector, average wages and salaries were more than 50 percent higher than average.
After the data has come in, it appears that high-paying oil and gas jobs are being lost in the oil and gas sector more quickly than they are being added to the other industries that might eventually replace them.. Note that this is directly opposite of the traditional predictive model that state two jobs replace every one that is lost. Oil and gas producing industries directly employ fewer than 500,000 individuals out of a total nonfarm workforce of 140 million, less than half of one percent, according to the Bureau of Labor Statistics. However, these employment numbers do not include the large oil and gas service industry we are all familiar with, or the steelworkers making OCTG (which alone employees around 7,500 workers making an average of $30 per hour, well above the average private sector wage). In other words, a decline in oil prices and production now has a substantive effect on the U.S. economy. While perhaps not enough to offset the gain, low oil prices are not nearly as beneficial as previously thought.
By: Ty Chapman
Five Star Metals, Inc.
Raising the Bar for Customer Service and Quality
Twitter: @FSM_TY
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