Tumbling gas prices make me feel like dancing when I pull into a filling station. Gas prices in Sarasota now hover near nationwide levels below $3 a gallon, according to AAA.
Prices of oil, the world’s most important commodity, have cratered over the past three months. West Texas Intermediate dropped below $78 on Tuesday after Saudi Arabia unexpectedly cut its prices further. If prices remain at current levels, global oil annual costs will decline $1 trillion to $2.8 trillion. Americans in turn will save some $250 billion, some $250 per family.
The Saudi price cut created worries about the resilience of the U.S. oil industry. According to analysts for Sanford Bernstein, about one-third of U.S. shale oil production would be unprofitable at current prices. Many of our small firms have large debt loads.
The lower prices enable consumers to spend more on food, clothing and housing, but the benefits from lower prices are less than in previous times because:
Though we remain a net oil importer, we are importing less of it.
Oil consumption has declined as a percentage of our economy.
Behind the price cuts
What factors have contributed to lower oil prices?
Global oil production in 2013 reached a new all-time high of 86.8 million barrels per day. Over the past decade, U.S. oil production, especially from the shale oil boom, has increased to close to 8.7 million barrels per day, a 28-year high.
It’s difficult to turn off the oil faucet. Most oil investment takes years of planning and cannot be cut precipitously, even if it becomes unprofitable.
The stronger U.S. dollar lowers oil prices. The dollar has risen 7 percent this year against other major currencies. When the dollar strengthens, the buying power of other nations weakens. Since globally traded oil is denominated in U.S. dollars, foreign countries must pay more to buy each barrel.
OPEC’s internal dissentions prevent cohesive decision making. Normally when oil prices are weak, OPEC reduces production. But the fighting in Iraq and Syria has divided the OPEC nations. Saudi Arabia, representing nearly a third of OPEC’s production, is intent on taking market share from Iran and weakening ISIS, which is heavily dependent on oil to fund its fight.
The tipping point for lower oil prices occurred Oct. 1, when Saudi Arabia cut prices for its biggest customers to defend its market share rather than prop up prices.
Demand has also dropped. Conservation, spurred by earlier high prices and green regulations, has dampened demand. For example, the average new car consumes 25 percent less gas per mile than 10 years ago. And abundant natural gas has cannibalized oil usage, especially for home heating. Power from renewable energy sources, including wind and solar, has risen to a record 2.7 percent of global energy consumption, up from 0.8 percent a decade ago.
Mixed effects
Lower oil prices have mixed effects on our country because we are simultaneously the world’s largest consumer, importer and producer of oil.
Good news includes that analysts at Goldman Sachs estimate that cheaper oil and lower interest rates should add about 0.1 percentage point to growth in 2015, estimated at 3 percent.
Bad news includes that lower oil prices are not good for the U.S. energy industry. The shale boom has created more than 2 million jobs, according to a 2012 study by HIS Inc. If that production is no longer profitable, those jobs will be cut.
Cheaper oil also could encourage the Fed to keep interest rates near zero even longer and make it more difficult for the Fed to maintain its 2 inflation rate target.
My career as a Wall Street bond trader made be fully understand the adage “and this too shall pass.”
A cardinal rule for successful trading is to reduce one’s position before a three-day holiday, and $3 gas might be just a temporary respite.
In the meantime, fill her up!
Originally published in the Sarasota Herald-Tribune
