By Chris L. Meacham, CPA, Cornerstone Wealth Management
No doubt you’ve noticed a substantial change at the gas pump lately as the cost of gas has dropped considerably over the past six months. In fact, the price of oil has dropped 40% since its peak in June of last year.
There are two main reason for this drop: one, economic growth at the global level has slowed which weakens demand. And two, the production of oil in the U.S. has been surging over the last couple of years. The impact of all this, of course, is much more far-reaching than just a cheaper trip to the gas station. Let’s take a look at who some of the winners and losers are of this trend on the global level and how it affects us here in the United States.
In general, those who are losing out the most, of course, are oil companies and countries with a large net oil export, as well as the high yield sector (with the energy sector making up over 20% of the high yield market in the U.S.). There are some countries, however, that will feel the hit harder than others:
Venezuela – One of the largest oil exporters, Venezuela is also tens of billions of dollars in debt, so their economy was struggling even before the oil prices dropped.
Russia – While Russia, also one of the world’s largest producers, does have some reserves to guard against the loss in oil revenue, a combination of sanctions from the west and a declining rouble have made Russia even more dependent on oil.
Iran – Iran may be in the most trouble. It spent 25% ($100 billion) of its GDP on consumer subsidies last year. And like Russia, heavy sanctions will make it nearly impossible to avoid big financial trouble.
Saudi Arabia – While many may assume Saudi Arabia will take the biggest hit, that’s not necessarily the case. Even though they are the largest oil supplier of the OPEC nations, Saudi Arabia would be able to weather the hit more than any other oil-producing country thanks to their rising foreign reserves. In fact, they could probably withstand decades of deficits which is why they remain steadfast in letting prices fall, mainly to ensure the production of U.S. shale oil does not increase and take some of their share of the market.
First off, the big winner is the world economy as a whole. Tom Helblin of the IMF says that a 10% change in oil prices is associated with around 0.2% change in a global GDP. This essentially shifts the resources from the producers to consumers who are more likely to put that money back into the market. Additionally, agricultural countries benefit greatly as agriculture is more energy-intensive than manufacturing. And seeing as how most of the agricultural countries are poor, this drop in oil prices is great news for struggling countries.
China – China is the one of the largest net importers of oil, and fortunately most of its manufactured exports have not dropped in price, so its economy should benefit greatly from this plunge in oil prices.
Japan – Japan imports almost all of its oil, so it should reap large benefits of cheaper prices. But the effects might also hurt the country’s economy. The higher energy prices have actually been pushing inflation higher and have been a part of the country’s economic growth strategy.
India – Similar to China, India is one of the top net oil importers, importing nearly 75% of its oil. Also like China, India’s exports have not taken a hit. Additionally, this drop in oil price should help control India’s inflation which would result in lower interest rates, thereby jumpstarting investment.
In the U.S.
The impact here in the United States is much more complicated, due in part to the fact that the U.S. is simultaneously the world’s largest consumer, importer, and producer of oil.
On one hand, the cheaper oil prices, along with a stronger dollar (which is at a five year high) will hurt U.S. exporting companies. Additionally, oil giants like Halliburton and BP will take considerable hits. Halliburton has recently lost 44% of its value, while BP has lost 25% in a matter of months.
On the other hand, however, the U.S. is still ultimately a net importer of oil, and its consumers are saving $630 million each day as compared to prices in June. If these current prices were to hold, that would equate to $230 billion saved over an entire year. That is a lot of money to be dumped back into the economy by consumers.
Yet even when this large boost in consumer spending (which makes up 68% of the U.S. economy) seems like a positive, Kathy Jones, a fixed-income strategist at Charles Schwab, points out that there still is a flipside to this. A large portion of U.S. investments are centered around the petroleum business. Jones says that 15% of Barclays U.S. high-yield index stems from oil and gas companies.
Likewise, the effects also vary depending on where in the U.S. you are. Obviously, here in California, the lower gas prices are a godsend. But in places like North Dakota, this is not necessarily good news. While the huge growth in U.S. energy production has been a main factor in the falling oil prices, it has also been a large source of North Dakota’s economy as it is the biggest state in shale oil production. But shale oil is expensive to extract, and subsequently, according to Reuters, shale oil permits for new wells has already dropped 15% since October.
All in all, this dramatic drop in the cost of oil will have enormous global ramifications. Some experts believe that it could be one of the biggest transfers in wealth ever. For example, revenue for OPEC members may be down $590 billion, which means all that money is staying in countries like Japan, China and the U.S.
However, if there is only one certainty in oil prices, it is that they are always fluctuating. Relying too much on predictions either way can be risky. That’s why we believe the best investment strategy is preparing for different outcomes by taking a carefully tailored and diversified approach in public and private investments.