Oil Supply, Energy Demand & the Rip-roaring U.S. Dollar: What it means for your portfolio

What do falling oil prices mean for the U.S. in the short and long term
Barry Ritholtz
Washington Post, February 14 2015

 

 

 

Since early 2014, the price of oil has plummeted. It peaked last year at $105 a barrel and is now about $50.The consumption and production of energy is a major component of the global economy. The huge drop in price has a significant impact in the United States — on corporate profits, employment and capital spending. Still, there has been a lot of misinformation — scare-mongering, really — about falling oil prices. A little context here can go a long way.

The economics of lower oil prices are nuanced and complex. Consider the questions it raises. What is the economic impact? Is the decrease in energy prices good for consumers and manufacturers? Or are falling prices a sign of waning economic activity? How much will corporate profits be hurt? What does this mean for hiring? And for your portfolio?

The overall impact of falling energy prices is felt in two steps. The immediate response is a decrease in energy sector profits. About 10 percent of the Standard & Poor’s 500-stock index’s profits are at risk. This relatively new information — the drop only started in September — is still making its way into the markets. The digestion of this information has created fear and market volatility, knocking the broad indices down by almost 5 percent. However, it is likely this is only temporary. Look for it to lead to an increase in consumer sentiment and spending, greater corporate hiring and bigger capital expenditures later this year.

What’s at work? Three factors drive the price of most commodities, including petroleum: the U.S. dollar, supply and demand.

Oil is priced in dollars. And it will trade inversely to the price of the world’s reserve currency. When the U.S. greenback fell in 2001 to 2008 (down 41 percent), the price of oil climbed over 500 percent ($22 a barrel to $147). As the dollar rallied 30 percent over the past five years, the price of crude oil has more than halved ($105 to $48). Think of the dollar as the measuring stick of oil; when the ruler changes size, so does the price of the measured goods.

Demand is the next factor. The United States — the world’s biggest consumer of oil (we use twice as much crude as China) — is not showing its usual post-recession uptick. Along with slower growth rates in Asia and the ongoing weakness in Europe, the global demand is softening.

A number worth noting: Americans drove 2.764 trillion miles in 2014, according to the government. From the November 2007 pre-crisis peak, total miles driven by all vehicles fell 3.65 percent.

In the meantime, hybrid car sales have climbed — the United States has about 3.5 million hybrid electric automobiles, second only to Japan. Even “clean diesel” car sales increased 25 percent in the first six months of 2014 (versus total U.S. car sales, up 4.2 percent).

That’s just transportation. As a fuel for electricity generation, oil is losing market share versus natural gas — it’s cheaper, cleaner and more reliable.

Supply is the last piece. Two notable changes from the past have occurred in the production of crude oil in United States and the behavior of Saudi Arabia.

The United States is producing nearly twice as much oil than it has in decades. It averaged a little over 5 million barrels a day in the 2000s. At the end of 2014, we were pumping over 9 million barrels per day. If these gains continue, the United States could become energy self-sufficient within a decade.

Saudi Arabia has responded to falling oil prices differently than they have in the past. Typically, its response to falling prices has been to cut back their production. That supply constraint was usually sufficient to brings prices back up. This time, they have chosen not to.

The immediate impact of lower prices has been negative. Up until now, oil exploration has been a source of high-paying employment. About 500,000 jobs were created in the energy sector since the recession ended. Capital expenditure — spending on rigs, pipelines and more — in the sector has also been robust. With falling prices, such spending is down.

Longer-term, however, the effects are more positive. Like so much else in the markets, energy prices are, by and large, a “zero-sum game.” One company’s loss is another’s gain. As exploration and drilling companies suffer a profit squeeze, transportation, retail and utilities benefit from lower fuel costs. Eventually the longer-term positive of lower energy expenses should replace the short-term negative.

The psychology of businesses and consumers adjusting to lower prices leads to a delay in changes in behavior. Doubts that the price change is permanent thwart additional spending. But the longer prices stay low, the more significant the changes. We have seen an uptick in the sales of SUVs, pickups and trucks — high-margin vehicles, sold primarily by General Motors, Ford and Chrysler. The longer oil prices stay low, the more of these profitable trucks will be sold.

Look at the entire nation of drivers: Every day oil is down $50 from recent highs, my back of the envelope calculations say American motorists collectively save up to $750 million on gasoline. Per day! If prices were to stay below $60 until September, that’s a windfall of up to $300 billion.

After a few quarters go by, consumers and businesses cannot help but notice more cash in their pockets and on their balance sheets. That is likely to benefit consumer and capital expenditures (corporate spending). Price drops could also give a kick to employment.

So long as the United States avoids a recession — and as of now, one does not appear on the horizon — look for the recent bumpiness to turn into economic gains and increased corporate profits. Neither of which is bad for your portfolios.

~~~

Ritholtz is chief investment officer of Ritholtz Wealth Management. He is the author of “Bailout Nation” and runs a finance blog, the Big Picture. On Twitter, @Ritholtz.

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  1. ironman commented on Feb 21

    Closely related: future earnings per share expectations for the S&P 500. As best as we can tell, virtually all of the decline in expected earnings throughout 2015 from our previous snapshot three months earlier (in mid-November 2014) is directly tied to the effect of falling global oil prices upon the U.S. oil industry and its supporting industries.

  2. large J commented on Feb 21

    was very excited to see you writing on Oil prices since you are a fact based guy. but i have to call you out on a perpetual fallacy that the US will achieve energy independence:

    “The United States is producing nearly twice as much oil than it has in decades. It averaged a little over 5 million barrels a day in the 2000s. At the end of 2014, we were pumping over 9 million barrels per day. If these gains continue, the United States could become energy self-sufficient within a decade.”

    70% assures that peak shale was within a year or two of our grasp and it is no more than 6-7mm bbl per day. you need $100 oil to even begin discussing shale getting turned back on. Guys like Continental are toast — they have a $10 per bbl cost differential i.e. a $10/bbl discount to WTI in the Bakken and they have never and will never have cash flow in excess of capital expenditures.

    lastly as you know you cannot extrapolate a growth curve in perpetuity — i know you know that but seem to have given yourself a pass — i am calling you out.

    other than that your blogs are awesome — you are awesome and there needs to be 50 more of you before the financial press can regain any sort of credibility — than you for doing what you do.

    ~~~

    ADMIN: Here is the quote in question: “If these gains continue, the United States could become energy self-sufficient within a decade.”

    That is an IF/THEN clause, not a prediction

    • large J commented on Feb 23

      you are using an “If then” argument to build your point — please don’t then back away from it as if you were not trying to support your argument –that is just inauthentic and the exact type of hypocrisy you point out all the time. It is a bullshit argument and you should know better — if my mother had wheels she’d be a bus. THIS IS NOW, AND HAS ALWAYS BEEN, AN UNSUSTAINABLE, UNECONOMIC GROWTH TRAJECTORY CURVE. Only a fool would extrapolate from it and you are not a fool. move on.

  3. Expat commented on Feb 21

    “The United States — the world’s biggest consumer of oil (we use twice as much crude as China) — is not showing its usual post-recession uptick.”

    You’re getting ahead of yourself, Barry. Or you are drinking the Kool-Aid. The reason US oil demand has not seen a post-recession uptick is that for most people (you are NOT most people…you are obviously 1% and beyond) the recession is real and ongoing.

    The narrative is that all is well because we are hitting record highs on stock indices. Well, we all know about trickle down, right? “Don’t piss on me and tell me it’s raining.”

    • Liquidity Trader commented on Feb 21

      You lack an understanding of what the word recession means.

      If you want to say this is a sub-par recovery — a typical, post-credit crisis recovery, you would be correct.

      But to make the bold bogus claim we are still in a recession is simply bullshit. By any metric you care to name, the economy has been expanding (not contracting) since 2010.

      Wages have been weak (especially for those lacking specialized skills or a college degree), but that is a 3 decade, post-Reagan story. Its nothing new or part of what happened due to the Great Recession.

    • Expat commented on Feb 21

      Well, stay classy.

      I measure recession by how well the economy and the actual living, sentient things we call “humans” are doing. I choose to measure in real terms (deflating back, say, twenty years or so). So based on real incomes, real unemployment, real debt and many other real measurements, I still call recession.

      You can be vulgar. You can be insulting. But apparently you can’t be intelligent or relevant.
      Hugs and kisses, Expat.

    • Liquidity Trader commented on Feb 22

      You can deflect from your error calling my response vulgar, but the simple fact is you are making crap up. If you haven’t learned anything from this site, its that data and facts matter, even if you don’t like them.

      You may feel it is your right to mischaracterize this as a recession. It is my right (nay, Obligation) to call bullshit on anything that is erroneous factually wrong or all three. Congrats on hitting the trifecta.

    • DMR commented on Feb 23

      @Liquidity Trader, you are using one specific technical indicator of a recession. One that is not universally accepted. Even the NBER, which is tasked with calling recessions in the US does not solely use this definition to date start and end of recessions.

  4. Futuredome commented on Feb 21

    higher dollar and lower oil=investment bubble warnings. Little surprise when the dollar fell in the fall of 2005, growth began to slowly drying up in 2006-7 while investment boomed overseas.

  5. SecondLook commented on Feb 22

    A number worth noting: Americans drove 2.764 trillion miles in 2014, according to the government. From the November 2007 pre-crisis peak, total miles driven by all vehicles fell 3.65 percent.

    There are socio-demographic factors to consider: An aging population; in general the older you are, the less miles you’ll do. The steady increase in retiree’s (reflected in the decline of the work participation rate); who no longer have the commute. The Millennials, who, apparently, don’t want that commute – and not just them, from the most recent report on mass transit:

    More Americans used buses, trains and subways in 2013 than in any year since 1956 as service improved, local economies grew and travelers increasingly sought alternatives to the automobile for trips within metropolitan areas…

    It isn’t always about the price of oil, that dictates our behaviors.

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