Some 41 years ago this week, the American way of life changed forever. With the Arab oil embargo and the quadrupling of crude prices, the age of cheap and abundant energy was over. Along with Watergate and defeat in Vietnam, the resulting long lines for gasoline and the double-digit inflation that accompanied them defined the 1970s.
Over those ensuing four decades, American consumers’ confidence has waxed and waned with what they pay at the gasoline pump in a way that was unimaginable previously when they could top up their Belchfire V8s with a $10 bill -- plus get their oil and tires checked and windshield cleaned while they picked up free roadmaps -- and get back change.
Subsequent jumps in oil prices almost invariably were followed by downturns in the economy, however. Digging deeper to fill their gas tanks invariably left less for consumers to spend for little luxuries for those who could afford them, and real hardship for those hard pressed to make ends meet. Conversely, dips in pump prices equally invariably were greeted as windfalls, equivalent to a “tax cut” for John and Jane Q. Public to take to the malls to spend.
That sensitivity of the U.S. economy to the vagaries of oil prices has made “energy independence” a priority for every president since Richard Nixon, who was still in the White House when 1973 embargo hit. Then, of course, there’s the geopolitics of oil, including the attendant costs in treasure and lives of American servicemen and servicewomen.
If not outright independence, the U.S. has markedly reduced its dependence on imported oil through increased energy efficiency and the expansion of domestic production via fracking, which has provided a stunning new cost advantage to American industry
But with the U.S. emerging as the world’s No. 1 oil producer, the calculus of falling petroleum prices is changing. To be sure, it still is positive—just not as positive as when the U.S. was just the world’s No. 1 consumer.
The impact on oil stocks and especially those involved in fracking has been dramatic. The Energy Select Sector SPDR exchange-traded fund entered bear-market territory Tuesday while the Market Vectors Unconventional Oil & Gas ETF is off nearly 30% from its highs.
Moreover, the tumbling price of crude also is being felt in the junk-bond market, writes Michael Aneiro in his Income Investing blog. Energy comprises over 17% of the high-yield market, by far the largest sector, as companies have availed themselves of this ready source of funds to finance expanding production.
This slide in oil prices might have knock-on effects on the U.S. economy, according to David P. Goldman, head of Americas for Reorient Group, a Hong Kong-based investment bank, and former head of credit research at Bank of America.
According to one estimate of a major institutional investor, the full-scale bear market in crude -- a 20% decline to $81.84 for the U.S. benchmark West Texas Intermediate, the lowest since June 2012 -- could boost U.S. gross domestic product by 0.3%. But that is only half the lift previously seen from such a drop in prices.
“Lower oil prices, to be sure, are good for consumer spending, but they are bad for investment and employment,” Goldman writes in a research note. “The U.S. oil and gas industry has added 400,000 jobs since 2003, and a February 2014 report by Mark Mills of the Manhattan Institute claims that an additional 2 million jobs have been added in transportation, construction and manufacturing due to the U.S. oil boom.”
“The cost of fracking has increased substantially since the early days of the boom. In 2003, the four largest fracking companies by market cap were getting about 40% more in cash from operations than their capital expenditure. Now cash from operations is less than $1 for every $1 of capex,” he continues.
“Given the enormous capital cost of expanding output, the U.S. oil and gas industry has become very price-sensitive. That explains the sharp drop in the sector’s equity prices over the past month. If the most successful (and the only really booming) sector of the U.S. economy cuts back on investment in response to lower oil prices, the net impact on the U.S. economy would be negative,” Goldman concludes.
So when you read about the supposed windfall from falling oil prices, consider the source -- probably a Wall Street strategist viewing them from the perspective of a gas-guzzling luxury sedan or SUV, and not that of a highly leveraged producer in the Bakken.
Authored by firstname.lastname@example.org