What’s better for the economy, weak oil prices or strong ones? What’s more beneficial for US economic growth, strong profits and capex spending by Big Oil or less pain at the pump for consumers?
Economists have been batting this issue back and forth as oil has slid lower for the last three weeks. The global economics team at Bank of America Merrill Lynch weighed in with the idea that a 25 dollar drop in US crude oil prices could be good for as much as 40 basis points worth of GDP growth over two years. That’s doesn’t sound like much – until you realize the global economy is bumping along at something like 2 percent annual growth these days (we’re looking 3ish while Europe looks 1ish).
Here’s Ethan Harris & Co on the effects of crude’s slide, through the prism of large producers versus your family’s ability to spend elsewhere:
The Big Five versus Joe Six Pack
How much does this boost growth? At first sight, not very much. After all, the US is becoming increasingly energy independent. The monthly energy trade deficit dropped to just $13.1bn in August. For argument’s sake, if we assume the trend since 2008 continues, the deficit will be zero by late 2018 (Chart 10). Hence, the windfall of lower prices to consumers is almost matched by the loss to producers. Nonetheless, we would expect a net stimulus to growth in the near term. The big oil producers are flush with profits and cash.
For example, the Big Five integrated oil and gas producers had a total profit of $93bn in 2013 and ended the year with cash balances of almost $60bn. With such a large cushion of savings, we would expect them to respond slowly to weaker profit growth. Of course, if oil prices remain very low, over time, this will discourage investment and eventually lower the growth in oil production.
By contrast, consumers will likely respond quickly to the saving in energy costs. Many families live “hand to mouth”, spending whatever income is available. The Survey of Consumer Finances found that 47% of families had no savings in 2013, up from 44% in the more healthy 2004 economy. Over time, energy costs have become a much bigger part of budgets for low income families. In 2012, families with income below $50,000 spent an average of 21.4% of their income on energy. This is almost double the share in 2001, and it is almost triple the share for families with income above $50,000.
Josh here – To me, the more interesting question is which is better for the stock market – weak or strong oil. Over the last three weeks, the correlation between oil prices and European stocks has been .90 – as close to a perfect correlation as you could ask for. Which tells me the sellers in both are worried about the same thing: Disinflation or deflation taking root globally. Hard to argue lower oil is good for stocks until we start to hear about consumers becoming emboldened because of it.
We’re not there yet.
Macro policy: no room for error
Bank of America Merrill Lynch – October 17th 2014