Yay for consumers, boo for producers? Photo credit: Justin Sullivan/Getty Images.
Gas is under $3 a gallon! Woo-hoo! What a bonanza for the US consumer! But headlines also suggest the sharply falling oil prices responsible for consumers' allegedly big gain bring producers pain. Particularly, the US shale drillers who have played a big part in driving up supply in recent years. While there is some truth to both the pluses and minuses of recently falling oil, we'd suggest not getting carried away with either. The reality, for both the benefits and threat of low oil prices, is more nuanced.
Since July 30-the last time West Texas Intermediate (WTI) crude prices topped $100 per barrel at $104.29-oil prices have fallen 21%, closing 10/20/2014 at $82.76.[i] While a 20% drop over three months may seem extreme, short-term commodity price volatility isn't uncommon. Consider: In 2011, WTI prices dropped from $113.39 on 4/29/2011 to $75.40 on 10/4/2011-a 34% drop over five months.[ii] In 2012, WTI prices jumped from $77.72 on 6/28/2012 to $98.94 on 9/14/2012-27% in under three months.[iii] Bouncy! Though global oil supply is up quite a bit, thanks in part to greater production spurred by the US's shale oil boom, that doesn't necessarily explain the recent steep drop. Sentiment is very likely at work. However, the big price drop has pundits speculating falling oil prices put the broader energy boom at risk.
For example, some forecast slowing production since prices in the $80 range generate a smaller profit for drillers. This could put unconventional oil and gas projects like deepwater and shale-the key drivers of the vast increases in oil production-at risk. In some cases, that's probably true. Drilling in the deepwater pre-salt formation off Brazil is no doubt costlier than in the shallow Gulf of Mexico, and there are already reports Petrobras may rethink its extensive exploration plans, perhaps in part due to increased global supply and stable prices over the last few years. If prices remain at the current or even lower levels for an extended period of time, other production projects may get shelved, prompting speculation that US shale firms are next to feel the pinch.
But thanks to improved efficiency, most US shale drillers expect to stay profitable even as oil prices fall-just 4% of US shale oil production needs prices to remain above $80 for producers to breakeven. Analyses vary, but some experts even estimate oil prices could drop to the $30-$60-a-barrel range before it starts hitting production in shale regions like Texas' Eagle Ford. Plus, given how time- and capital-intensive oil extraction projects are, most firms likely won't-and perhaps can't-alter planned production solely based on a couple months of bumpy data. Fears energy companies will curtail business plans on a dime are likely overwrought. After all, the aforementioned Petrobras wind down comes after years of stable prices, rising supply and government shenaniganery involving the wacky state-run driller. The recent drop may prove the coup de grâce, but it likely wasn't the sole motivator. Major oil firms are well acquainted with the wiggles and jiggles of the oil market, and they are unlikely to react to what amounts (at this point) to short-term volatility. Longer term, yes, perhaps.
Likewise, lower oil prices' impact on gasoline prices-and the alleged positive effect on the American consumer-is also overstated, in our view. Some call consumer spending America's $11 trillion shield from a turbulent world, one that's bolstered by falling gas prices. Besides the obvious fallacy here-that America needs shielding from a growing global economy-consumer spending isn't exactly an impassible moat around the US.[iv] Now it's true, consumer spending is more than two-thirds of US GDP. And yes, saving money at the pump could mean some folks have a wee bit more discretionary cash to spend on more exciting things. But cheaper gas prices do not make the US consumer "stronger."
Where spending happens, whether it's on gas, an extra Christmas gift or a new bauble for your Festivus pole, isn't as significant as if it's happening. That is a winners and losers argument, not a growth or no growth one. Additionally, consumer spending is usually a stable factor in overall economic growth. For example, during the last recession, consumer spending didn't fall off nearly as much as exports and business investment. Folks may not have splurged on vacations, but they aren't going to stop buying essentials like medicine and gasoline. Besides, if some large percentage of the 75% of global GDP that isn't the US were heading for a recession (that's not the case today), it is highly unlikely the US consumer could do anything to prevent the economy from feeling the impact. To think otherwise disavows history and strikes us as pretty Pollyanna.
Now don't get us wrong-in our view, the US economy is at the forefront of the developed world underpinning the current expansion. And with many still doubting a nicely growing global economy, it's a reason to be bullish. For investors, however, not all "good news" is necessarily bullish. Pundits may trumpet or warn about lower oil prices, but drilling past the headlines unearths a bunch of noise. Oil prices rising and falling may pick some winners and losers on the margin, but we doubt it's a key driver going forward.
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[i] Source: St. Louis Fed, West Texas Intermediate Crude Oil Prices. Data last updated 10/22/2014.
[iv] Yes, we know. The US doesn't need a moat because it has those two shining seas on the eastern and western edges.
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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.