Do Lower Gas Prices Really Boost Consumption?

The recent plunge in oil prices has brought both optimism and pessimism to the economic landscape. Anyone who lives in Houston, as I do, knows that the price of oil is an important driver of the economic landscape. The plunge in oil prices in the 1980’s is a solemn memory for many Houstonians, particularly for those in the oil patch that lived through it.

The problem with falling oil prices, economically speaking, is that oil and gas production make up a hefty chunk of the “mining and manufacturing” component of the employment rolls. Since 2000, when the oil price boom gained traction, Texas has comprised more than 40% of all jobs in the country according to first quarter data from the Dallas Federal Reserve.

Higher oil prices have led to more employment as energy companies explored and developed more aggressively. This has particularly been the case since the financial crisis as cheap financing has lead to an exploration “boom” in “shale fields.”  However, as I discussed recently, there is a dark side to that “miracle”.

“First, the development of the “shale oil” production over the last five years has caused oil inventories to surge at a time when demand for petroleum products is on the decline as shown below.”

The drop in demand is being driven, no pun intended, by a change in demographics, a rise in telecommuting, a structural shift in unemployment (large pool of working age individuals outside of the labor force) and increases fuel efficiency. These dynamics are likely not to change in the foreseeable future as economic growth rates globally continue to “muddle along.”

The obvious ramification of the surge in supply as demand stagnates is a “supply glut”which leads to further declines in oil prices. As prices fall, energy related business cut production by “shutting in” wells, cutting capital expenditure plans (which makes up almost 1/4th of all capex expenditures in the S&P 500), freezes and/or reductions in employement, and declines in revenue and profitability. Of course, the “ripple effect” of those actions impacts all of the related and ancilliary businesses from piping to coatings, trucking and transportation, restaurants and retail.