What Falling Oil Prices Mean for the U.S. Economy

Posted by Brad McMillan, CFA, CAIA, MAI

Find me on:

This entry was posted on Oct 15, 2014 12:09:24 PM

and tagged Investing

Leave a comment

falling oil pricesApart from the stock market—and we got a break on that front yesterday—the big story lately has been falling oil prices.

Not to minimize the market’s losses, but from a long-term perspective, the oil price decline over the past month is the more important story by far, both for the U.S. economy and for the world.

Some time ago, I wrote that the changing supply-and-demand picture for oil would lead to further price declines. Well, I was right in terms of direction but wrong on timing—it’s happened much faster than I expected. One reason is that several countries have chosen, for budgetary reasons, to keep producing oil rather than pull back on production to keep the price high.

Saudi Arabia plays the waiting game

Saudi Arabia, in particular, has said it’s prepared to live with lower oil prices for some time. Since the Saudis have historically been able to adjust oil prices by changing their own production, this is significant; the Organization of Petroleum Exporting Countries (OPEC) won’t try to lift the price until the Saudis say so.

Of course, Saudi Arabia isn’t motivated by altruism, but by a desire to retake dominance in the market. With prices low, other producers—in OPEC itself and even in the U.S.—are less motivated to explore and produce, which, over time, should limit future production and push prices back up. The Saudis, buoyed by low production costs and large reserves, can afford to play a waiting game.

Who will be the next price-setter?

The assumption on the Saudis’ part, though, is that they will remain the price-setter in the oil market. I don’t think that’s the case.

As U.S. production rises, and demand continues to grow more slowly or even shrink, the ability of any state to set prices diminishes. Particularly in the most important market—the U.S.—prices are constrained by production costs. Currently, U.S. production costs are higher than those in Saudi Arabia, but they’re declining daily as the technology improves.

The benefits of lower prices

For the U.S. economy, lower oil prices have notable advantages:

  • In the short term, lower oil prices are an unambiguous good for the U.S. economy, freeing up consumer cash for things that provide a greater economic boost. Each $0.10 decline in gas prices equates to about an additional $120 per year in consumers’ pockets.
  • Longer term, increasing domestic production and investment means more U.S. jobsand more oil money that stays in the U.S.

Plus, as the U.S. plays a larger role in oil production, the world economy is more stable, and less subject to disruptions in the Middle East. Countries such as Russia and Venezuela, which depend on oil revenue, are facing increasing budgetary challenges that limit their ability to make trouble around the world. The decline in U.S. oil imports has also resulted in a stronger U.S. dollar.

The downward trend in oil prices looks like it will continue for some time. Disruption is possible, of course, but as U.S. production continues to grow, it becomes less and less likely. That growth is part of what the Saudis are trying to slow—because for them, the U.S. assuming oil leadership is a serious problem.

CTA_BradsBlog

Upcoming Appearances

Tune in to Bloomberg Radio's Bloomberg Businessweek on Friday, February 28, at 3:45 P.M. ET to hear Brad talk about the market. Stream the show live at https://www.bloombergradio.com/, listen through SiriusXM 119, or download Bloomberg's app, Bloomberg Radio+.

Tune into Yahoo Finance's The Final Round on Thursday, March 12, between 2:50 and 4:00 P.M. ET to hear Brad talk about the market. Exact interview time will be updated once confirmed. Watch at finance.yahoo.com

Subscribe via E-mail

New call-to-action
Crash-Test Investing
Commonwealth Independent Advisor

Hot Topics

Have a Question?

New Call-to-action

Conversations

Archives

see all

Subscribe

Disclosure

The information on this website is intended for informational/educational purposes only and should not be construed as investment advice, a solicitation, or a recommendation to buy or sell any security or investment product. Please contact your financial professional for more information specific to your situation.

Certain sections of this commentary contain forward-looking statements that are based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is not indicative of future results. Diversification does not assure a profit or protect against loss in declining markets.

The S&P 500 Index is a broad-based measurement of changes in stock market conditions based on the average performance of 500 widely held common stocks. All indices are unmanaged and investors cannot invest directly into an index.

The MSCI EAFE Index (Europe, Australasia, Far East) is a free float‐adjusted market capitalization index that is designed to measure the equity market performance of developed markets, excluding the U.S. and Canada. The MSCI EAFE Index consists of 21 developed market country indices.  

Third party links are provided to you as a courtesy. We make no representation as to the completeness or accuracy of information provided at these websites. Information on such sites, including third party links contained within, should not be construed as an endorsement or adoption by Commonwealth of any kind. You should consult with a financial advisor regarding your specific situation.

Member FINRASIPC

Please review our Terms of Use

Commonwealth Financial Network®