A Weblog Dedicated to the Discussion of the Christian Faith and 21st Century Life

A Weblog Dedicated to the Discussion of the Christian Faith and 21st Century Life
I do not seek to understand that I may believe, but I believe in order to understand. For this also I believe, –that unless I believed, I should not understand.-- St. Anselm of Canterbury (1033-1109)

Monday, January 25, 2016

There Are No One-Armed Economists: The Good and the Bad of Cheap Crude Oil

The following post is by my friend, Michael Kruse who blogs at Kruse Kronicle:
Are low oil prices good or bad for the economy? The answer is clearly "yes." But maybe a little more detail would be helpful.

Low oil prices have some obvious benefits. On Wednesday, I put 13 gallons of gas in my car for about $21.It would have cost me $40 just a couple of years ago. I estimate our annual household savings could be $750. A more mobile household could easily save more than $1,000.

Then, the gas bill came. It was 41% percent ($70) less than what we paid for the same period last year. The weather has been milder but the bill says our charge per unit has dropped 24%. We could easily save a few hundred dollars more this year. Your savings might be substantially more.

Put this into perspective. A $1,000 reduction in expenses in a household with the USA median income of $50,000 functions as 2% rise in living standards. And because gas and home heating are generally higher percentages of budgets for lower-income households, the living standard boost is even higher for them. But there is more.

There are production and transportation costs built into almost everything we buy. Hundreds of everyday items have petroleum as an ingredient (ex. Personal care products, drugs, food, medical equipment, solvents, ink, and most anything plastic.) Lower oil prices reduce the cost to produce and transport goods, allowing businesses to keep prices lower. This boosts our household living standard even more.

So clearly, low oil prices are a good thing, right? Well, Harry Truman famously pleaded for a one-armed economist because every economist to whom he put a policy question would tell him about the likely positive impact only to follow up with "on the other hand," then listing all the negative impacts. So, on the other hand …

The oil and gas industry makes up about 5-6% of the global economy. The USA had $220 billion dollars in revenues for the industry in 2014. It is a huge piece of the American economy. But the impact goes further than just this industry. Petroleum and its byproducts must be extracted from the ground, processed, and transported. Steel, aluminum, rubber, and host of other materials are needed to manufacture the equipment and vehicles used by the industry. That demand creates skilled well-paid employment in these other secondary industries that create and maintain the items the oil and gas industry needs.

There has been a 50% growth in oil and gas revenues since 2010. The industry has been an important contributor of growth in well-paying jobs in an otherwise sluggish American economy. The supply of oil and gas has kept growing into this past year. That alone would have put downward pressure on oil and gas prices. But also in the past year, we have seen dramatic economic slowdowns in China, Brazil, and in much of the developing world. That means demand has slowed just as the supply has expanded. Down goes the price.

The oil and gas industry is accustomed to wild swings in commodity prices. However, the present low prices are now below what oil companies can charge and still earn a profit. A short-term dip to these prices is a bit of a problem but a more extended dip, or a new normal, will lead to a major shake-out in the global oil and gas market. (Some analysts suggest it will be years, maybe decades, before we see a return to sustained higher prices. Saudi Arabia is not cutting production hoping to keep the supply high and thus price low enough to drive Americans out of the market.) Companies will curtail operations. Some may go out of business. Thousands of well-paying jobs will be lost, as will the economic demand pay from those jobs would have generated. (There have already been thousands of layoffs and a spike in foreclosures in oil drilling regions.) The myriad of businesses that supply to the oil and gas industry will also retrench, cutting jobs and canceling orders for the supplies. And on the ripple effect will go through the economy. In an already sluggish economy, there is potential for recession.

So which will win out? An economic boom due to increased standards of living from low oil and gas prices, or a recession due to a collapse of a huge industry that has been a key component of our otherwise sluggish economic growth? Analysts are not certain but the combination of a vulnerable American economy and the problems in emerging markets makes them worry that it will be the latter. And that is why not only have my energy costs come down but the value of my 401K has as well.

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