There are a lot of scary things going on in the world markets today, especially since the beginning of this year. Oil prices have collapsed to levels that no one would have imagined just over a year ago.
Crude oil prices have imploded from over $100 per barrel in mid-2014 to below $30 this week. Gasoline prices have plunged from above $3.50 per gallon to below $2.00 in many parts of the country.
That is supposed to be a good thing, right? Yet in recent days commentators have blamed the latest stock market nosedive on collapsing oil prices. So the key question today is, how did plunging oil prices go from a good thing to a bad thing?
Oil is a commodity. Commodity prices have a long history of over-shooting both on the upside and the downside. I know this because I have been in the commodity business for over 40 years. I began my career after graduate school in September 1975 as a commodity trader for one of the largest agri-business conglomerates in the world.
The point is, I’ve been around the block when it comes to seeing unexpected swings up and down in commodity prices. And I can tell you that what we’re seeing in oil and energy prices today is really nothing new. Let’s take a closer look and I’ll try to answer the question above.
The price for West Texas Intermediate Crude Oil (WTI) has collapsed from above $110 per barrel in 2014 to near $27 a barrel during yesterday’s trading session, but rebounded to just above $28 by the close.
Crude prices may be headed even lower – some predict $15 a barrel– but you just never know with commodity prices. As noted above, they frequently overshoot on the upside and the downside.
The reasons for both the overshoot to the upside in recent years and the overshoot to the downside recently are fairly obvious. The prevailing wisdom from about 2000 until about 2011 was that we were running out of oil (ie – “Peak Oil”), and in recent years that prices would remain at or above $100 indefinitely.
Yet as we all know, US oil producers came up with revolutionary new ways to extract more oil from the ground (fracking, horizontal drilling, etc.) since 2010. Ditto for oil producers around the world. Daily crude oil production set new all-time record highs in 2014 and 2015.
In short, by late 2014 and 2015, we had gone from fears of a potentially acute oil shortage to a glut. Thanks to President Obama’s Iran nuclear deal (don’t get me started!), and the lifting of sanctions, Iran is now clear to start unleashing its vast oil supplies on the market just ahead, which could drive prices even lower.
Our question today is when did lower oil prices go from a good thing to a bad thing? Lower energy prices are unquestionably a good thing for consumers. Simply put, when consumers spend less for gasoline and other energy resources, they have more to spend on other things, which is good for the economy.
I saw one report last week that said for each dollar consumers are saving on gasoline, they are spending up to 73 cents of that savings on other goods and services. That seems a little high to me, but you get the point – that additional consumer spending should be boosting the economy in a significant way.
Yet as I pointed out in my E-Letter on Tuesday, the US economy is slowing down markedly. The Atlanta Fed now estimates that 4Q GDP growth rose only 0.6%.
So, it now appears that falling gasoline prices are a bad thing for the economy, and that is one of the main things driving stocks lower day after day. Here’s why. When oil prices started falling last year, most forecasters suggested that crude prices would likely decline to the $50-$60 area.
And most economists concluded that a decline to that level would be a good thing which would spur consumer spending and the economy. Yet as we all know now, the decline has sent oil prices to less than half that level.
The concern now is that, despite the pocketbook benefits to consumers, the crash in crude prices may mean widespread bankruptcies across the energy sector. Likewise, it could mean sovereign debt defaults in nations that depend heavily on oil prices (think Middle East producers, Venezuela, Mexico and even Russia and others). Plus, tens of thousands of workers in the energy sector have already been laid off, with more layoffs likely to follow.
This is why the equity markets have gone from welcoming falling oil prices to fearing them.
I will have more to say on this in coming weeks but will leave it there for today. Hope this helps.