Oil falls below $50 a barrel on Jan. 5, and the Dow Jones Industrial Average plunges nearly 330 points. Seems like an open-and-shut case that the price plunge is getting to be a problem. People remember that in 1998, a sharp decline in the price of oil contributed to a Russian default that rocked the global financial system.
Not quite. Cheaper oil is still creating more winners than losers. Far more people live in oil-importing countries than live in oil-exporting countries. The U.S., for one, remains a net importer. The well-publicized travails of U.S. shale oil producers are small compared with the gains by American consumers and businesses that are paying less for gasoline, diesel, jet fuel, petrochemicals, and the like. With fuel prices down, people are driving more miles and buying more cars and trucks.
Do the math: Close to 70 percent of the U.S. economy is consumer spending, which will gain from cheaper crude. Only about 10 percent is capital spending, of which 10 percent to 15 percent is the energy sector. That comes to roughly 1 percent of U.S. output, which might decline 20 percent this year, making it a relative drop in the bucket of U.S. gross domestic product, says Nariman Behravesh, chief economist for IHS Global Insight.
Why, then, did stock prices fall when West Texas Intermediate for February delivery dropped nearly $3 a barrel on Jan. 5, to $49.89? Mostly because of market fears about global growth, which weighed down both stocks and oil prices, says Gus Faucher, a senior economist at PNC Financial Services. In other words, the latest drop in oil is a symptom, not a cause, of economic weakness, Faucher says. “Anyone who thinks that lower oil/gasoline prices is a net negative for the U.S. (and the global economy) is brain dead, economically speaking!” argues a Dec. 23 report by Faucher’s boss, PNC Chief Economist Stuart Hoffman.
The one fly in the petroleum jelly is the risk of some kind of financial crack-up like the 1998 Russian default. “You will always have financial risks associated with fast, unexpected changes,” says Anders Aslund, a senior fellow at the Peterson Institute for International Economics. “The big problem with this oil sell-off is that it surprised everyone and no one has really prepared for the risks it poses.” The biggest risk isn’t the low price but the uncertainty, which could freeze investment and spending, says David Rosenberg, chief economist at Gluskin Sheff & Associates, a wealth management firm.
True enough. But the fear of a financial crisis is probably overblown. Even Venezuela, the oil producer most often said to be at risk of defaulting, is likely to keep making payments on its debt as long as oil prices don’t “fall to the low $30s for an extended period of time,” argues Francisco Rodriguez, who follows the Andean economies for Bank of America Merrill Lynch. Even at today’s low prices, Venezuela’s annual export earnings are more than four times what it owes in principal and interest in 2015, Rodriguez says. And, he adds, President Nicolás Maduro knows that if Venezuela defaults, creditors will attempt to seize refineries outside the country that are valued at around $20 billion.
Russia is on the verge of “a complete economic disaster,” says Aslund, but its problems are likely to remain localized this year. Because Russia is sitting on reserves of more than $300 billion, it has even less reason than Venezuela to default, says George Abed, a senior counselor and director of Africa-Middle East for the Institute of International Finance.
If fears of an oil-induced financial crisis were seeping into the market, you’d expect to see it show up in the stock prices of banks, which would be vulnerable to a wave of defaults. It hasn’t happened: Stock prices of the Standard & Poor’s index of diversified banks—which includes the likes of JPMorgan Chase (JPM) and Citigroup (C)—are up more than the overall S&P 500 over the past half year.
What is true is that further price drops would probably produce smaller gains than the decline to date. “The negative impact on investment starts to ratchet up” if oil stays below $50 a barrel, says Douglas Handler, chief U.S. economist at IHS Global Insight. In fact, the price drop might knock so many producers out of the market that there will be a steep price rebound, says Steven Kopits, an oil analyst at Princeton Energy Advisors. “The incremental benefits get weaker,” Kopits says. OK. But that’s a long way from saying that cheap oil is too much of a good thing.
