Oil Prices: A Divergence in the U.S.

“Oil prices getting lower. Great! Like a big Tax Cut for America and the World. Enjoy! $54, was just $82. Thank you to Saudi Arabia, but let’s go lower!” Mr. Trump tweeted on Nov. 21.

Tweets like this from President Trump reflect the opinions of many Americans: cheaper oil means cheaper gas for consumers, saving money for everyone.

With the current boom in U.S. oil, though, which is pushing America towards being a net oil exporter, this trend is not as clear cut anymore. In current times, cheap oil can be quite a drag on the economy as a whole.

U.S. Energy Investment

A large cause for this divergence is the booming business investment from the explosion of U.S. oil.

fredgraph(1)
Figure 1, Investment in Mining Exploration, Shafts, and Wells

Figure 1 above from FRED shows this investment trend. Fixed investment in exploration, shafts, and wells reached $202 billion at the end of 2014, just over 8% of all private investment in the U.S. at the time. Investment reached a low of $68 billion in 2016 after prices fell bellow $40 a barrel, helping to create an overall drop in private investment between the fourth quarters of 2014 and 2016.

A drop in $134 billion is no small amount for an industry that contributes so much to overall investment. The industry has become so influential to the overall economy that this bust attributed to the slower economic growth in the U.S. during 2015.

With oil production up over 11 million barrels a day currently, a drop off in investment with falling oil prices could hamper our economy even more than it did in 2014-15.

Higher Debt Oil Companies

On top of this large overall investment contribution, current U.S. oil companies are far more susceptible to drops in cash flow now. Due to the high debt  loads of the industry, lower prices severely hamper modern oil firms.

Lower prices make it difficult to finance this debt, and many companies refer to $50 as the inflection point. When prices fall below this benchmark, production has to be cut back.

This was not as much of a problem for more traditional oil companies like Exxon and Royal Dutch Shell, who relied on large rigs for their oil pumping. These rigs needed big upfront investment but could then pull out oil for decades with minimal cost, allowing these companies to carry minimal debt.

Companies that have formed since the fracking revolution rely on much smaller shale deposits and must constantly invest in new wells and equipment to maintain production.

The Consumption side

Regardless of the oil industry, Americans still consume a lot of oil. Gasoline and fuel expenditures totaled to $346 billion in the second quarter of 2018, and are on an upward trend. With less efficient light truck sales out pacing car sales, this trend is likely to increase.

Cheaper gas saves everyone money, especially the growing number of people with larger, truck based vehicles. With winter right around the corner and heating systems being turned on as well, cheap oil benefits most Americans on the consumption side of things.

The Big Picture

Overall, President Trump is correct that many Americans are receiving a “tax cut,” but with oil being such a large part of our economy now, lower prices are not a unanimous benefit (I haven’t even mentioned the indirect benefits from the oil industry, like new strip malls and home building in areas such as the Permian Basin).  Economists predict lower prices will reduce GDP growth by 0.3% over the next year, striking a more negative tone than the president.

We will see over time which area of the economy is more dominant: our hefty gas consumption or our booming oil investment.

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