Economic Impact of the Crude Oil Price Crash

Economic Impact of the Crude OilPrice Crash• Overall History of Petroleum Prices 1980s to Present• Comparison of 1986 and 2014 crashes• Position #1 – Crash is result of falling demand worldwide; Recent increases in US production have made usvulnerable to price decline; overall impact is negative• Position #2 – Crash is result of increased productionworldwide, OPEC cheating; negative impact on USproducers is less than benefits from low energy prices Crude Oil Prices from 1983 to 2016 (WTI, Cushing OK)160140120100 Price in Current US$ per Barrel 806040200 Dec-86Dec-94Dec-02Dec-10Dec-82Dec-90Dec-98Dec-06Dec-14 Reasons for Crude Oil Price Declines• Recession or other demand shock:• 1991 – GHW Bush recession• 9/11 attacks and aftermath• Great recession of 2007-8• China slowdown and European recession of 2015 ?? • Supply shock:• OPEC cheating, Saudi Arabia loss of control in 1986• OPEC cheating, Saudi Arabia abandons role in 2014-16?? Comparison of 1986 and 2014 Crude Oil Declines • Background to 1986 crash:• Iran revolution in 1979 raised prices• Iran/Iraq war caused both countries to raise oil output• By 1985, Saudi Arabia lost control of OPEC output limits• Domestic production increases in US added to supply • Data• Refiner acquisition cost drops from $35 to $15 per barrel• WTI futures price drops from $30 to $12 per barrel• US GDP continues to increase strongly Crude Oil Price Collapse 1985-1987Mid-month price Cushing OK35 30 25 20 15 10 5 0Jun-85 Sep-85 Dec-85 Mar-86 Jun-86 Aug-86 Nov-86 Mar-87 May-87 Current Crude Oil Price Crash• Background to current crash:• After end of Great Recession, crude prices rose strongly• China demand for strategic reserve, to support growthwas a major factor• US tight-oil production (Fracking) has skyrocketed • Data• Crude oil futures prices dropped from >$100 per barrel to$30 per barrel in February 2016• US GDP continues to increase Crude Oil Prices from 2013 to 2016 (WTI, Cushing OK)12010080 Price in Current US$ per Barrel 6040200 Jul-13Jul-14Jul-15Jul-16Jan-13Jan-14Jan-15Jan-16Jan-17 Real Quarterly GDP – 2010 to 201616,900.016,700.016,500.016,300.016,100.015,900.0GDP in $Trillion 15,700.015,500.015,300.015,100.014,900.014,700.014,500.02010 2011 2012 2013 2014 2015 2016 2017 Proposition #1 – World Demand is Slowing• This claim is difficult to assess – EIA & internationalagencies report consumption & supply, not demand• Economist reports latest 2016 GDP numbers:• CountryRecent QtrOne Year Ago• E.U.• U.S.• China• India• Brazil + 1.8 %+ 3.5 %+ 7.0 %+ 8.3 %- 3.3 % + 1.8 %+ 1.7 %+ 6.8 %+ 7.3 %- 2.9 % Impact on Energy Producers is Negative • Many petroleum workers were predicted to lose jobs;in 2015 600K people worked in oil & gas operations• WSJ reported regional banks could be affected – in the1980s, 700 banks failed in Texas alone• Council on Foreign Relations report predicted negativeimpact for economies of WY, WV, TX, OK, ND, NM, LA• EIA “Today in Energy” article stated that below $60per barrel, frackers would start to lose money Negative US Economy Impacts from Oil Crash• USA Today reported 6 of 8 oil-producing states are inrecession: AK, LA, NM, ND, OK, WY; only TX and MT stillgrowing (Nathan Bomey, 1/24/17)• Rig counts peaked in the U.S. at 1596; bottomed out at 320last May; as of November, they were up to 462• Since the crash, 150,000 oil workers have been laid off, andhundreds of firms have filed for bankruptcy (OilPrice.com, asaccessed on 1/25/17) Proposition #2 – Impact will be Beneficial • The same CFR study cited above shows total elasticityof employment w.r.t. oil prices is -0.02• A 10 % reduction in oil price should lead to a 0.2%increase in overall employment• A 50 % reduction in oil price would lead to a 1.0% increase • The US still is a net importer of energy – net importsas % of consumption are still 26% Saudi Arabia and Iraq’s Efforts were Temporary• Saudi Arabia suspended production quotas to drive down prices,but deficits caused them to run assets down quickly• Iraq increased production in anticipation of Iran’s re-entry; Iranis now shipping to world markets; Iraq’s production has slowed• In the fall of 2016, OPEC announced reductions in sales bothinside and outside the cartel – in an attempt to shore up prices• History has shown us that predatory pricing seldom is effective;harvest-and-invest strategies do not work if potential suppliersremain on the sidelines Low Petroleum Prices Change Incentives • Distinction between spot prices and contract prices is critical –most petroleum is bought and sold under contract; theseprices fall and rise more slowly than the spot market• Use of forward and futures contracts allowed many producersto hedge against low prices in 2015 & 2016; new long termcontracts are in the $50-60 per barrel range, not $30-40• As prices fell, producers with large reserves had increasedincentives to leave petroleum in the ground; those countriesthat could cut production are doing so now Comparing 2014-16 to 1986-88• In the late 1980s, economy handled bankruptcies, joblosses, and bank failures in oil-producing states; USgrowth remained strong through low-price period• Wealth transfer back to US helped fuel consumptionboom – 1980s became known as Decade of Greed• Currently, we seem to be on the same path; no broadimpact of oil states recessions; financial systemunaffected; some evidence that low energy prices areagain building wealth in energy consuming countries Overall Evaluation of Low Oil Prices• Net benefit for US economy; impact on petroleumsector has not spread to rest of economy• OPEC was unable to destroy unconventional USproduction (esp. fracking); damage to Saudi, Nigeria,Venezuela, other OPEC economies has been profound• Re-imposition of tighter quotas has caused a modestincrease in prices, some relief for US producers• CFR study seems to have been on target