Low oil prices and the national economy

In our last edition of the Voice, we discussed the potential effects of the decline in oil prices on the Texas region. The fall in energy prices has the potential to cost the Texas economy 125,000 to 150,000 jobs. This week, we’ll look how declining oil prices could affect the national economy.

Most of us are saving $20 to $30 dollars per tank, which means consumers have more money to spend elsewhere. In addition, most of the country north of Texas depends on heating oil or natural gas for heat. Most homes will use $900 to $2400 per year for heating, taking into consideration all types of heating sources. So again any cost savings in oil save these homeowners even more.

It is estimated that there’s an additional $13 billion more in consumers’ pockets since the oil downturn. So where did the savings go? U.S. consumers actually used a big chunk to drive more, go to the movies more, and eat out more. All that explains why holiday season sales improved when holiday sales started slowly. Cheap gas helped retailers salvage a season that started off slowly.

Consumer Growth Partners, a retail industry consulting firm, used Department of Commerce to estimate where the $13 billion in gas savings were spent.

• $4.9 billion more was spent on simply using more gas, so the oil companies actually saw higher consumption at the pump

• $1.8 billion more went to entertainment and services, such as movies, theme parks, content downloads, and smart phone subscription/service fees

• $1.3 billion more was spent at restaurants, fast food, and bars

• $1 billion more went to things like tobacco, beer, and other “sin” products

• $4 billion more went to retailers, broken down as follows;

o Food and beverage stores: $1.5 billion

o Home improvement: $1 billion

o Clothing: $1 billion (this is a key category for department stores like J.C. Penney and Macy’s)

o Consumer electronics: $500 million

U.S. shoppers had $1 billion more in disposable income than last year from other factors, and that helped areas like toys and sports.

There’s also a psychological by-product to the rise and fall of the price of gas. We watch the neighborhood gas station prices like a stock ticker, and we assume that falling prices will translate to better economic times ahead, at least in terms of our personal budgets. Drops in gas prices of even a penny can improve consumer confidence. The consumer confidence indicator is currently at its highest level in almost eight years. I think many of us see the savings almost like a tax rebate. It’s not much, we really don’t plan for it long term, but we welcome the savings.

But as the United States has shifted from being overwhelmingly a consumer of oil to increasingly a producer, the collapse in the price of oil, now below $50/barrel, will have unpredictable side effects for large and diverse sectors of the economy. This includes not just the oil and gas industry, but also finance, manufacturing, and more. The US gained ground in its production from using higher cost methods of producing oil (fracking). These methods of extraction cease to be profitable below $70/barrel.

In the first week of January alone, the number of active drilling rigs in America fell by 61. Each rig employs 50 to 60 people. That’s more than 3,000 potential job losses right there. Oil rig employment peaked in late September 2014, and 180+ rigs have gone idle since, taking with them 9,500 to 11,000 jobs, and that’s just the jobs that are directly tied to the process of drilling.

By the way, those are well-paying jobs. In North Dakota, for instance, the average salary in the oil and gas industry was $111,000 in 2013, more than double the state average, which itself was goosed higher by those high oil and gas wages. They are the kinds of jobs America desperately needs.
Many analysts and economists have been overjoyed at the headline unemployment numbers improving. Our economy added 252,000 jobs in December, and unemployment fell to a 6½-year low. But when you look hard at the numbers, guess what? Nearly 60% of the jobs were in low paying industries such as auto parts salesman, home health assistants, and hospitality. 17.5% of America’s new hires were in food service – waiters, cooks and bartenders.

So, while you and I saved $20+ per fill up, that ‘windfall’ means America is losing six figure per year jobs in the oil patch for less than $10.00 an hour jobs with little to no benefits. Not a good trade.

Once these jobs are lost, you cannot just ‘turn the spigot’ back on. The longer term affect of losing too much investment or stimulating demand could create a price shock in future years as necessary supply growth cannot return quickly once curtailed.

So what are the benefits and negatives of oil values softening?

The positive

Financial experts are excited for when and where consumers spend the money saved on fuel. More dispensable income means more cash spent at malls, movie theatres, and restaurants. This influx of spending holds down inflation and boosts both local economies and the stock market. Energy spending constitutes a bigger part of the budget for lower-income families, lower oil prices help counter some forces that have worsened the inequality of income, wealth, and opportunities.

Dropping prices also help industries not reliant on oil. The automobile industry may benefit from dropping oil prices. Last year was the automobile industry’s best since 2006, according to the National Automobile Dealers Association, with almost 17 million cars and trucks sold. A surge in jobs and more income from lower gas prices gives Americans the ability to buy a new car, perhaps for the first time in a decade.

Lower oil prices will benefit farmers and will eventually benefit consumers as food prices drop. Agriculture is very energy intensive – a dollar of farm output takes 4 to 5 times more energy to produce than a dollar of manufacturing output. That cost savings is then passed on to the consumer in less money spent for groceries.

Lower fuel prices means consumers will be able to travel more. Consumers haven’t seen a drop in airline prices yet. This is because airlines contract to buy fuel in advance, so there is a lag in savings when oil prices drop. But with demand for flying high and the fall in oil prices keeping costs low, airlines are in a profit sweet spot. Nearly all major airlines hit record profit margins during the June through September quarter. Historically the industry has shown in a strong demand environment that they don’t plan to proactively cut fares.

All in all consumers should have more money to spend. This in itself sounds good after the harshness of the recession. However, only 65 counties out of 3,144 are at prerecession numbers or better. That is just over 2% of America’s counties that have recovered. Yes, the national economy is recovering, but we are still over 55% short of prerecession economic numbers with few parts of the country participating. You take away oil production, that number gets divided by more than 50%.

So while low energy prices are immediately good for the consumer, oil is responsible for a lot of jobs and economic activity.

The negative

The obvious impact is oil companies downsizing. Not just big oil, but all those small companies that make their livelihood from the extraction and sale of oil will get hurt from the plummet in oil prices. Not just those directly or secondarily involved in the industry, but the mom and pop stores, diners, and locally owned stores in these areas. Although the lower oil prices are almost certainly temporary, the economic aftershocks will take longer to overcome.

Anything associated to steel and metals suddenly has to revaluate their strategies, and invariably that includes downsizing or closing. This has a definitive long term effect on the rust belt as it tries to recover. Most of this is outside our Texas region.

The nation’s recovering GDP will also suffer, since the energy companies have been doing most of the ‘heavy lifting’ of large capital investment at a time where other sectors have chosen not to or are unable to invest long term in their future.

Falling oil prices are bad for the environment because cheaper oil means fewer incentives to develop alternative and less carbon-intensive sources of energy. Most of these alternatives make sense when oil is above $70/barrel. The falling prices reduce the incentive to develop new oil and gas fields and make it less urgent to create alternative energy sources. That hurts companies in those areas and, because it makes energy less plentiful, means higher costs and fewer energy alternatives once global demand revives.

As prices decline even more, segments of the economy that enable drilling, like the companies that build pipelines, pumps, and drilling rigs, will curb their own investments. In the worst case, even existing equipment would be left idle, further reducing industrial activity. These pullbacks would reverberate well beyond the oil industry itself, into areas such as steel, cement, and other fields that supply the oil industry. This affects much more than our Texas region, reaching into almost all industry and regional sectors as capital investment sits idle.

To increase state and government revenues for new road infrastructure, many support an increase in fuel taxes. America’s fuel taxes are some of the lowest in the world. Also remember most expect these values to be temporary. Taxes based on long term low values is not a popular nor a prudent decision unless we want to be buying $5.00 gas long term. Setting long-term policy in response to volatile oil prices can create unintended consequences. Five years from now, some countries will face much lower prices. Others will be paying more. That may alter global trade and development in ways we can’t predict today.

This is not a plea for the high values we have seen up to last year. Most analysts feel that was unsustainable. But realize that the oil values of today are caused by speculation. Speculation is not a predictable factor for basing long term policy or predicting economic impact.

As stated before, $50/barrel for the Texas region for 90 days is bruising. 180 days or more could have dire effects on the economy. How does this affect you and I? The next six months will tell.