photo by Darin Marshall
Motorists celebrating the return of sub-$3-a-gallon gasoline will be quite disappointed if it turns out that this year’s dramatic drop in oil prices is short-lived. There is a chance this could happen - but probably not a very big chance.
A sharp acceleration in the economies of China and much of Europe might quickly burn off the world’s current excess supplies. So might a big expansion of government-held fuel reserves, while an abrupt drop in the dollar’s value could drive up the prices Americans pay at the pumps.
None of these things seem to be in the cards, however, at least not in the near future. Europe’s problems are deeply rooted in too much bureaucracy and too little labor market freedom. The United States is beginning to emerge from its easy-money era while the eurozone and Japan are just seriously entering theirs, which argues for a stronger rather than weaker dollar. And governments always put a higher priority on building their emergency stocks when resources are scarce - and thus expensive - than when they are abundant and cheap.
It looks as though lower oil prices are going to stick around for a while. Yesterday’s column examined some obvious and not-so-obvious causes for the decline. Today, I want to look at who is likely to benefit most from the new environment, and who is apt to be harmed.
Happily for the U.S. and most of its allies, many of the regimes that will be hurt worst by the drop in oil prices are not constructive global actors. A Russian recession, which the country’s economy minister now predicts, will leave Moscow with fewer resources for potential aggression in Eastern Europe and elsewhere. We have already seen Vladimir Putin’s regime abandon a proposed pipeline to Europe, though the Russians are painting the move as Western Europe’s loss. Inflation in Russia has already climbed above 8 percent, according to The Washington Post.
The Russians are not the only ones feeling pain from Saudi Arabia’s refusal to play its traditional role as the world’s swing producer by cutting production to balance supply and demand at a higher price level. As I observed yesterday, the Saudi policy seems to be aimed largely at its regional archrival Iran, and secondarily at other Gulf states that have been supportive, behind the scenes, of radical Islam in ways the House of Saud finds threatening. The decision not to scale back production is only aimed in a tertiary way against emerging oil producers like the United States and Canada, the latter of which will be more directly affected by falling prices. Here in the United States, it is not always that expensive to frack for oil, and transportation costs to get oil from wells to refineries are also lower. As we produce more of what we need, Americans are not the Saudis’ natural primary market anyway. If the Saudis can undermine or undersell producers in Russia and Iran, they can take greater market share in Europe and Asia.
How will lower oil prices will affect the United States itself? The question is complicated, because we are a big producer of oil, but also the world’s largest consumer. For now, we are still a net importer, which means lower oil prices are an overall benefit from a national perspective. Lower oil prices will certainly have an adverse impact on certain regions, however, especially in Texas and the Northern Plains states. But that economic pain will also ultimately prove temporary.
In some ways, it may even be beneficial, especially in the Northern Plains, where infrastructure is sorely lacking. The cost of living is disproportionately expensive in many of these places. A town in North Dakota topped the list of expensive locations for renters earlier this year, beating out the San Francisco and New York metro areas by average renter cost, mainly because of insufficient supply relative to demand. A slowdown may give boom towns some time to catch up to the influx of money and workers they were initially unprepared to handle, because while drilling will slow with lower prices, it is unlikely to stop entirely. In many places, though not all, oil will still be profitable at $60 or $70 per barrel.
In the aggregate, the costs of a slowdown in demand will almost certainly be more than offset in the U.S. by the benefits of lower energy prices, especially for middle- and low-income Americans. The falling price of gasoline is the quick and obvious result, freeing up money budgeted for transportation to flow elsewhere in the economy. But in the Northeast, heating oil can also be a big expense, especially if we have another cold winter. The U.S. Energy Information Administration forecasts an average cost for heating oil of $3.27 this winter, down over 15 percent from last year. But oil prices overall have dropped so much in the time since the forecast was made that we could see heating oil prices more like those of the winter of 2009-10, when heating oil was $2.85 a gallon. If we did, that would be a drop of nearly one-third. Cheaper heating oil, especially when it is so much cheaper, will help a lot of people here this winter.
Falling gas costs will also help people in China, where consumers have, in recent years, bought more cars than the residents of any other country, including America, by a wide margin. Gas prices there tend to be similar to prices here, though they are a little higher, so we would expect a similar benefit when prices dip. China, too, imports more of its oil than we do. A drop in prices will be just as stimulating to the world’s number two economy as to the world’s number one economy, if not moreso. Since China is a major consumer market now, this outcome is also good news for commodity producing nations, such as Australia and Brazil, that have struggled recently, as well as for Europe, which is a major exporter of luxury goods to China.
Overall, lower oil prices could add 0.5 to 1.0 percent to global growth next year, according to Andrew Kenningham, senior global economist for Capital Economics.
Dropping oil prices will also deeply impact alternative fuels, which will be losers in this scenario except to the extent that they are politically protected. The mandate to mix ethanol with gasoline, about which I have written before, makes even less sense now that we are a major oil producer and the price of oil has dropped. A little over a year ago, the Environmental Protection Agency proposed reducing the requirement for ethanol production which, along with delays in setting the Renewable Fuel Standard, has drawn harsh criticism from Iowa’s Gov. Terry Branstad. (The EPA has said it will not finalize the standard before the end of the year.) The low price of oil will not do ethanol’s supporters any favors. Still, don’t expect any potential presidential candidates to demand the elimination of the ethanol mandate with the Iowa caucuses just 14 months away.
Lower oil prices will cast a spotlight on the distortions in our energy policy. For instance, on hot summer days across the country, people with solar power make money by selling back their excess to utility companies at artificially high prices. Utilities are often required to buy this power, even if it would be cheaper to turn on an oil- or gas-powered turbine to meet peak demand. In effect, this is a hidden subsidy, paid by people without solar installations to those with them. Some people might say this is just fine, because it acts to discourage the burning of fossil fuels. But regulators in several states are examining the matter, concerned that utilities will struggle to maintain reliable infrastructure under this system. In effect, it’s a carbon tax by another name. As the price of fossil fuels drops, this implied carbon tax rises, and the issue becomes more pressing.
Oil price movements always plant the seeds of their own reversal. A few years ago, we heard that the world was running out of oil and that the oil remaining was in remote, difficult and dangerous places to drill. Yet, at $100 a barrel, we found ways to tap plenty of oil here in the Lower 48. Nobody outside Alaska is talking today about drilling in the Arctic National Wildlife Refuge.
If prices fall below $50 per barrel, there will certainly be a sharp financial downturn in the oil patch, and a lot of working-class people who currently make big paychecks are going to feel the pain. But eventually, lower prices will encourage greater consumption, while cheaper drilling costs will promote more exploration. The commodity price cycle will continue, and in the long run, we’ll be better off for it.