The big news in the financial world for the past few months has been the dramatic drop in oil prices. Since June oil has lost nearly 50% of its value and is now at a price not seen in over five years during the depths of the recession. Although the signs have been around for a while, the sudden and protracted decline has taken everyone by surprise. We’re now seeing all sorts of explanations, justifications, and ruminations about what it all means.
Aside from homeowners in the Northeast who heat their homes with heating oil, the big impact on most of us is the lower gas prices to fill up our cars. If you’re like me, unless there is some big news about it, we really don’t notice fluctuations at the gas pump. However, when prices drop this much, it’s hard not to notice something is up. And in this case, that something is we have more money left over when we pull out. For most of us it’s certainly a good time of the year to have that kind of pleasant surprise.
A lot of people, unfortunately, don’t see it that way. Some of them think that lower prices aren’t such a good thing. I guess some people can’t get into the holiday spirit.
The esteemed liquidity expert and chronicler of the debt crisis John Mauldin has just dispatched a report on the oil price’s effects on overall growth. There’s a lot of information here, muddied somewhat by the gratuitous inclusion of the tinfoil hat brigade at Zero Hedge, who’ve never met an economic event they didn’t think was going to cause the collapse of Western Civilization. Here’s the important takeaway:
Employment associated with energy production is going to fall over the course of next year. It’s not all bad news, though. Employment that benefits from lower energy prices is likely to remain stable or even rise. Think chemical companies that use natural gas as an input as an example.
I am, however, at a loss to think of what could replace the jobs and GDP growth that the energy complex has recently created. Certainly, reduced production is going to impact capital expenditures. This all leads one to begin thinking about a much softer economy in the US in 2015.
Thankfully, Mr. Mauldin dismissed the more ridiculous assertions going around that the drop in oil is a replay of the subprime credit crisis, but that does still leave us with a picture of the energy industry facing serious problems. The emergence of fracking has been an absolute boon for those communities sitting on shale oil and gas fields. One would expect their fortunes to be reversed when the price of oil drops.
One immediate area that is starting to see some signs of life since oil dropped is employment of young workers. Now, kids in retail and entry level jobs may not restore confidence in those who see collapse of mighty industries around the bend. On the other hand, all the consternation lately about the rise of the machines, technological unemployment, and the lack of relevant job skills has a lot to do with companies unwilling or unable to invest in training unskilled and entry level workers because it’s simply not affordable. Kids getting jobs again is definitely a step in the right direction to correcting the mismatch. Except in overly regulated states, that is.
Unlike every other state in the United States, California increased its minimum wage on 1 July 2014, just as the employment situation was about to improve across the entire country thanks to falling oil and fuel prices. No other state has likewise implemented an increase in their minimum wages during this period.
By arbitrarily increasing their minimum wage from $8.00 to $9.00 per hour in July 2014, California’s politicians effectively jerked away the prospect of finding employment from its job-seeking teen population at a time when it would have its best chance at doing so in years, while also damaging their prospects for increased future earnings. All by making it too costly for the state’s employers to employ them profitably.
Which tells us the real danger to growth isn’t the natural movements of markets but the unnatural manipulation from government.
As for where the rest of the growth is going to come from to offset the decline in energy sectors, if the oil industry existed in a vacuum then there would be something to worry about. However, the fact is they sell to other industries and to consumers who will have more money to spend. Period. It’s not just petrochemical industries either. Car companies and heavy equipment industries and airlines and shipping companies and on and on and on.
Why some people choose to ignore these benefits and obvious upside is somewhat baffling. Luckily I’m here to let them know: absent some other unforeseen shock, lower prices will definitely and absolutely create more jobs then it will destroy. End of story.
But what about the energy industry? Surly lower prices will bankrupt it, end the American energy renaissance, and enslave us all to Arab Petro-Sheiks forever, right? It turns out that immense capital intensive projects like oil drilling take a long time and aren’t as responsive to price fluctuations. North American production is still expected to grow in 2015, mostly because there’s no alternative. The easy oil coming from Saudi Arabia that everyone believed was close to or at the peak is still probably running out. Sticking a straw into the ground and slurping up oil was great while it lasted, but it really is increasingly a thing of the past. That’s not a bad thing as new technologies naturally spring up to replace it and introduce innovations that bring the price down where it probably should be in the first place.
Likewise, high prices encourage the discovery of new technologies that allow explorers to find and recover previously untapped reserves of oil. And high oil prices encourage the development of alternative sources of renewable energy, allowing us to shift away from the use of hydrocarbons altogether. In the graph, we can clearly see how these incentive effects worked to bring oil prices back down in the 1800s and the 1980s. Most likely, these same incentive effects will work to push oil prices lower in the years ahead.
For years there was manipulation and a geopolitical premium on the price of oil. Now prices are dropping because the market is actually working correctly again. Let’s welcome it and allow it to continue.