Oil prices have declined significantly since June 2014, and many economists expect prices to remain low into the immediate and medium-term future. According to a March 2015 World Bank report, “The cumulative oil price decline between June 2014 and January 2015 was the third largest of the past 30 years and was driven by a ‘perfect storm’ of conditions that exerted strong downward pressure on prices.” The World Bank report cited several causes that have led to the drop in oil prices, including changes in supply and demand, a shift in the Organization of the Petroleum Exporting Countries’ (OPEC) policy regarding price targeting, fewer than expected spillovers from geopolitical risks and significant appreciation of the United States dollar.
Does cheaper oil help or hurt U.S. consumers, corporations and the economy? In this month’s Latest from the Lakefront, we will examine this question and look at some of the positive and negative impacts of cheaper oil.
The Positives:
- Consumers stand to benefit the most from the lower oil prices. The lower prices will free up money that can be spent on other things, bolstering the overall economy. Cheaper oil also benefits some U.S. industries that are dependent on fuel.
- Lower oil prices boost consumer confidence and increase disposable income. The U.S. government estimates that, on average, consumers will spend $750 less per household on gasoline in 2015 than they did in 2014, which is the equivalent of a tax cut.
- Inflation may remain low as a result of continued low energy prices. This eases one of the large concerns of central banks and may result in continued easy monetary policies in the U.S. and in oil-importing countries abroad.
- Some U.S. industries benefit from cheap oil. Examples include the automobile industry, airlines, transportation and retailers.
2014 was the best year for car sales since 2006, and a similarly good year is expected for 2015. - A major operating expense of any transport-based company, like airlines and delivery companies, is fuel cost. While many airlines hedge a portion (10-20%) of
these costs, sustained lower prices will certainly help their bottom line. Some airlines, like American Airlines, don’t hedge fuel expenses and stand to benefit
greatly as oil prices drop. - Retailers stand to benefit most from the increase in consumer spending due to lower gas prices. restaurants and hotels will also benefit because of increased disposable income, as will banks and credit card companies, which may see an increase in transaction fee revenue.
- Business spending may increase in some of the industries greatly impacted by fuel costs. American Airlines announced last year that they will invest $2 billion to upgrade flying facilities.
The Negatives:
- Lower oil prices negatively impact oil producers, both in the U.S. and abroad. The capital markets also may take a hit as the lower oil prices negatively impact the energy sector.
- U.S. shale production has contributed to the increased global oil supply over the last few years. States like Texas and North Dakota have ridden this boom and experienced brisk economic recovery since the Great recession. Together, Texas and North Dakota account for about 50% of all crude oil production in the U.S.
- More recently, oil producers have begun to pull drilling rigs out of these regions. The impact of a decline in drilling and oil revenue hurts those working directly in the industry and hurts the general economies in these states. Job loss and reduced profits at these companies may lead to reduced capital expenditures, a strain on the U.S. economy.
- Lower oil prices can be a drag on the energy sector, which makes up a significant percentage of the capital markets. It’s estimated that the energy sector in the U.S. accounts for 7% of equity market capitalization, 10% of the investment-grade bond market and 16% of high-yield bonds.
- Oil-exporting countries that rely on oil production as a major source of revenue may encounter fiscal problemsfor example, Venezuela has seen severe losses as oil prices have declined. In January 2015, Moody’s downgraded Venezuela’s government bond ratings, citing a “marked increase in default risk owing to lower oil prices.”
- Alternative energy becomes less attractive. A consumer is less likely to buy an electric or hybrid automobile when gas prices are cut in half. Companies engaged in alternative energy will have slower growth in a period of declining or low energy prices. Innovation in alternative energy also may slow.
The Bottom line:
U.S. consumers have more money in their pockets, and depending on the industry, low-priced oil can be a boon or a bust. While an increase in consumer spending should boost GDP, a slowdown in the U.S. energy economy will likely offset some of that increase. The U.S. is a net importer of oil but is also the largest producer of oil, so while the impact here is mixed, this is expected to be a positive. It’s not entirely certain what the net impact lower priced oil will have on the U.S. economy, but most economists believe it will be a net positive.
Source: Northwestern Mutual
