This page has been archived and commenting is disabled.
Falling Energy Costs And Economic Impacts
Submitted by Lance Roberts via STA Wealth Management,
"If you repeat a falsehood long enough, it will eventually be accepted as fact."
In the financial markets and economics it is a common occurrence that the media and commentators will latch on to a statement that supports a cognitive bias and then repeat that statement until it is a universally accepted truth.
When such a statement becomes universally accepted and unquestioned, well, that is when I begin to question it.
One of those statements has been in regards to plunging oil prices. The majority of analysts and economists have been ratcheting up expectations for the economy and the markets on the back of lower energy costs. The argument is that lower oil prices lead to lower gasoline prices that give consumers more money to spend. The argument seems to be entirely logical since we know that roughly 80% of households in America effectively live paycheck-to-paycheck meaning they will spend, rather than save, any extra disposable income.
As an example, Steve LeVine recently wrote:
"US gasoline prices have dropped for more than 90 straight days. They now average $2.28 a gallon, which is remarkable considering that just a few months ago, some of us were routinely paying $4 and sometimes close to $5.
Not so coincidentally, the US economy surged by 5% last quarter, and does not appear to be slowing down. "
If you read the statement, how could one possibly disagree with such a premise? If I spend less money at the gas pump, I obviously have more money to spend elsewhere. Right?
The problem is that the economy is a ZERO-SUM game and gasoline prices are an excellent example of the mainstream fallacy of lower oil prices.
Example:
- Gasoline Prices Fall By $1.00 Per Gallon
- Consumer Fills Up A 16 Gallon Tank Saving $16 (+16)
- Gas Station Revenue Falls By $16 For The Transaction (-16)
- End Economic Result = $0
Now, the argument is that the $16 saved by the consumer will be spent elsewhere. This is the equivalent of "rearranging deck chairs on the Titanic."
Increased consumer spending is a function of increases in INCOME, not SAVINGS. Consumers only have a finite amount of money to spend. Let's use another example:
Example:
Big John Has $100 To Spend Each Week On Retail Related Purchases
- Big John Fills Up His Truck For $60 (Used To Cost $80) (+$20)
- Big John Spends His Normal $20 Per Week On His Favorite Craft Beer
- Big John Then Spends His Additional $20 Savings On Roses For His Wife (He Makes A Smart Investment)
-------------------------------------------------
Total Spending For The Week = $100
Now, economists quickly jump on the idea that because he spent $20 on roses, there has been an additional boost to the economy. However, this is false. John may have spent his money differently this past week but here is the net effect on the economy.
Gasoline Station Revenue = (-$20)
Flower Show Revenue = +$20
----------------------------------------------------
Net Effect To Economy = $0
Graphically, we can show this by analyzing real (inflation adjusted) gasoline prices compared to retail "control purchases." I am using "control purchases" as it removes retail gasoline sales, automobiles, and building materials from the retail sales number to focus more on what consumers are buying on a regular basis.
The vertical orange line shows peaks in gasoline prices that should correspond (according to mainstream consensus) to a subsequent increase in retail sales.
Another way to show this graphically is to look at the annual changes in Personal Consumption Expenditures (PCE) in aggregate as compared to the subsection of PCE spent on energy and related products. This is shown in the chart below.
While the argument that declines in energy and gasoline prices should lead to stronger consumption sounds logical, the data suggests that this is not the case.
The reason is that falling oil prices are a bigger drag on economic growth than the incremental "savings" received by the consumer.
Oil and gas production makeup 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.
The obvious ramification of the plunge in oil prices is that eventually the loss of revenue will lead to cuts in production, declines in capital expenditure plans (which comprises almost 1/4th of all capex expenditures in the S&P 500), freezes and/or reductions in employment, and declines in revenue and profitability.
The majority of the jobs "created" since the financial crisis have been lower wage paying jobs in retail, healthcare and other service sectors of the economy. Conversely, the jobs created within the energy space are some of the highest wage paying opportunities available in engineering, technology, accounting, legal, etc. In fact, each job created in energy related areas has had a "ripple effect" of creating 2.8 jobs elsewhere in the economy from piping to coatings, trucking and transportation, restaurants and retail.
Simply put, lower oil and gasoline prices may have a bigger detraction on the economy that the "savings" provided to consumers.
Newton's third law of motion states:
"For every action there is an equal and opposite reaction."
In any economy, nothing works in isolation. For every dollar increase that occurs in one part of the economy, there is a dollars' worth of reduction somewhere else."
I live in Houston, and the face of fear in 2015 is that oil prices remain low.
»
- 9061 reads
- Printer-friendly version
- Send to friend
- advertisements -
OB is the Messiah
OB is the Messiah
OB is the Messiah
https://video.search.yahoo.com/video/play;_ylt=AwrT6VviBqNUJCkANJYPxQt.;...
I would have thought the mining sector would be loving these "deflationary" fuel costs lately to help offset the rest of their cost margin to dig up the precious.
I love the economic assumptions like Big John buying craft beer with the extra, more likely his wife likely used it at the grocery store on a luxury like a chuck roast....
One of the better posts explaining the zero sum game of income and consumer spending. I likey!
who wants to be a million dollars that the dow finishes above 18K tomorrow?
What's this thing cost?
http://www.msn.com/en-us/news/us/delaware-sized-gas-plume-over-west-illu...
Delaware-sized gas plume over West illustrates the cost of leaking methaneMethane?
Who run Bartertown?
As early as next month, the Obama administration will announce new measures to shrink New Mexico’s methane cloud while cracking down nationally on a phenomenon that officials say erodes tax revenue and contributes to climate change. The details are not publicly known, but already a fight is shaping up between the White House and industry supporters in Congress over how intrusive the restrictions will be.
Republican leaders who will take control of the Senate next month have vowed to block measures that they say could throttle domestic energy production at a time when plummeting oil prices are cutting deeply into company profits. Industry officials say they have a strong financial incentive to curb leaks, and companies are moving rapidly to upgrade their equipment.
http://www.msn.com/en-us/news/us/delaware-sized-gas-plume-over-west-illu...
Another Conspiracy Theory becomes Conspiracy Fact.
The anti-free energy coalition of Big Power and OBie.
sarc
DOW on its way to green.
Not this time.
the walking dead mkt only knows green. wait till tomorrow the dow is going to get pushed up at least 350 to 400 points. the days of us ever seeing a 17k handle again over. 18K and above for our lifetime!!!! when in doubt add stocks with a high price. nothing say properity like a price weighted average.
please, 'mericans don't do math.
The spice must flow.
Time for some Keynesian to pipe up in a squeaky voice and regale us with the broken window story (fallacy).
I know I'm not worse off because of cheap fuel no matter how much They try and make me feel bad. Oil workers should do like home builders and find a new career like moonshining or something.
Good idea genius, I think tomorrow I'll wake up and be a dentist.
How about you be my first customer?
Did I hurt your little feeling.
Instead of modeling in terms of dollars or gold, one should model in terms of added value. Example, a business hires someone who previously didn't have a job. Does this expand the economy? Using a dollars model, the answer is no because money is taken from the employer and given to the employee. Using a value added model, the answer is yes because more value is being added; someone went from unemployed to employed, so the overall productivity of the economy increased even though the number of dollars simply shuffled around.
Do falling oil prices expand or contract the economy? In this case, falling prices actually contract the economy because it leads to layoffs. People who were working a few months ago are no longer working. Less value is added to the economy. This is bad.
The price by itself tells you nothing about what's going on. Is this good deflation or bad deflation? Good deflation is when prices fall due to increases in productivity, such as cheaper computers every year. Bad deflation is when there's no demand for the product. Oil is definitely the bad kind of deflation. The price is not falling because we suddenly have too much of it. The price is falling because there's nobody to sell it to.
My first thought is to question the GDP print not the price.
Why did oil prices collapse? I don't think it was because lower prices are bad news. Unless of course youre a speculator "trading on winter."
My God! Winter! Never had one of those before!
The reason why everyone is so terrified is because there is so much debt "that has to be paid by higher everything." Think I'll wait until Spring before buying anything...
If the DOW doesn't close green I will lose my confidence in rigged markets.
I live in Houston and totally agree.
I'm sort of thinking of selling my house and moving to my weekend place in Somerville to shed property tax, insurance, maintenance, hoa, insurance both home and auto and just live in a mechanical room at work, while I have work. I worry that shortly there wont be any money here for.anyone to buy houses.
I want out. Fuck this shit.
"I want out."
Now you are thinking.
OIL is just the latest commodity to get sucked into the global deflationary vortex. One by one, every asset class is succumbing to the downwardly spiraling pressures. Stocks are the last of the holdouts and they are on their last leg. Fed credit expansion has peaked and now the crutches that held up the stock markets have been tossed aside. Nobody wants anymore credit...
http://www.globaldeflationnews.com/jaguar-inflation-a-laymans-explanatio...
EWTMAN.....thanks. "fed credit expansion has peaked"!!!!! no more shit articles about "peak oil" "peak earth". after all this is financial blog...."PEAK FED" should be the toast of zero hedge!!!!!!!
http://wallstreetonparade.com/2014/12/david-bird-missing-wall-street-journal-reporter-foresaw-an-oil-crash/
Convenience stores make most of their profit off the higher priced stuff they sell. Sodas and Milk, Coffee and sandwiches. If the consumer spends less on gas, then maybe they buy a bigger coffee and perhaps spurge on a large hoagie. I hit a WAWA every morning on my way to work and I see what they are buying. Stuff that they would normally pay less for at a supermarket, they pay much more when they stop for their morning coffee.
Bullshit article.
How about I buy some gold or some land with the savings that I didn't have to spend at the pump? Fuck you and your "need to spend all my money on gas" bullshit.
Grimaldus
He may be right, but he may be wrong. Nobody knows for sure. You have to make a lot of assumptions to prove that lower oil prices help. But it's an easier case to make than the case lower prices hurt overall. There are the classic income and substitution effects to be considere and also investment multipliers.
According to the EIA, we will be net Importers of 2.3 B bbls of crude this year. A $40/ bbl savings is around $90B of net savings to the US economy before all the assumptions. (I'm leaving nat gas out of it). We will produce around 3B barrels this year. So US producers lose $120B of revenue if prices stay at these levels.
Assumptions:
1) We will not blow all the $90B at Walmart on Chinese crap (that is to say that the marginal demand for imports will be far less than $90B). Likely. Positive
2) The investment multiplier effect for this added 90B of consumption in the US will be greater than the loss of the domestic oil industry's investment multiplier. Unlikely. mild Negative
3) The $120B of lost revenue by the US oil industry will be spent on other consumer goods. Likely, as marginal propensity to consume is 95%. 5% negative, ceteris paribus
4) Most of this 120B will be spent in the US. Likely. (sames as point 1). Some leakage through imports, mild neagtive
5) The revenue gain of 120B by other consumer goods companies will result in similar investment multiplier effects in the US as the oil industry. Unlikely. mild negative
It's a mixed bag, but it's probably a net positive. Mr. Roberts' analysis is incomplete and simplistic.
For him to be right, you have to believe the $90B savings will be overwhelmed by negative investment multiplier effects of the $120B lost to the US oil industry versus the $120B gained by other US industries (less marginal imports of course). This possible, but highly unlikely.
And how many gin and tonics can you get for $16?
3 +tax ;)
It is a huge disappointment when I read 5th grade analysts post on ZH. Somebody please screen these individuals. The gas station makes cents per gallon whether the retail price is $5 or $2.
you're killin me smalls
I see why this post only got one star. Because it is sooo stupid! Ok we get it that this might effect oil drilling in Texas and ND. But the rest of us going to have a party! And what you forgot to mention in this stupid post is low oil price means less of our paycheck going overseas to buy oil.
An earlier article pointed out that 69% of Americans were using the pump savings to pay down existing debt, not make new purchases.
And chasing the constant rise in food prices.
Gross receipts pay bills, period. It's an zero sum game. We don't need to try and over complicate things by breaking it down to determine net profits...
It's not a zero sum game. It's a zero currency game.
Gasoline Prices Fall By $1.00 Per Gallon
Consumer Fills Up A 16 Gallon Tank Saving $16 (+16)
Gas Station Revenue Falls By $16 For The Transaction (-16)
Gas Station EXPENSES Falls By $16.
Gas Station sees a net change in profit of $0.
Oil Company sees it's profit fall by $1.60 (as it reduces it's prices).
The consumer will get his 16 gallons and a Roses for his wife.However since most of the country is in debt, the consumer will likely pay down debt (deflationary), allowing banks to loan out more which will lower rates. Lower rates will give many consumers respite before the oil industry starts laying off people.
The real winners are the small businesses that also consume gasoline and must travel to make their living. Their lowered expenses will mean they can lower their prices or increase their margin (usually a little of both). Economic activity increases.
Which will be stronger? The decrease in economic activity from the layoffs or the increase from the occasional John buying Roses while the rest simply pay off debt.
It's only zero sum IF the purchase of one thing is exactly equal to the underlying economy as the other. All purchases are not equal in economic effect. IF it were then stealing from Donald Trump and then spending it would be a zero effect. It isn't. How Donald spends his money, i.e. invests it in productive wealth creating investments is not equal to spending that money on food or gasoline or rent.
Purchasing gasoline is not the same as purchasing a steak in the USA. IF the gasoline was sourced from crude oil from Venezuela or Saudi Arabia or Canada, that purchase is funneling money out of the country, a net reduction in economic assets in the US. Purchase a steak instead, 100% of that money stays in the US. The real number that needs to be followed is the Net Import and Export number.
"Gasoline Prices Fall By $1.00 Per Gallon
Consumer Fills Up A 16 Gallon Tank Saving $16 (+16)
Gas Station Revenue Falls By $16 For The Transaction (-16)
End Economic Result = $0"
This is a perfect example of confusing currency with money.
Production is money. Digits are just currency.
Energy is a factor of production. When energy is cheaper in terms of everything else, then everything else becomes cheaper down the line.
So, no, the economic result is not zero.
The common mistake is made in the other direction, when people note that $3.50 gasoline now is more expensive than $.50 cent gasoline was in the 1950's or 1960's. When you correct for published inflation it isn't much if any more expensive. When you correct it for inflation using raw economic prices of the time (i.e. comparing the gas price to other prices) it absolutely is not more expensive.
Similarly, gas isn't really cheaper right now. Instead you had a printing press redistributing capital from developed economies to energy producers, making gas more expensive HERE while less expensive THERE, and when the printing press stopped the capital hemorage slowed making the prices HERE AND THERE more equal than before.
Add to that a price war leading to temporary discounts. ERGO - oil still costs more, but the producer is eating a portion of the cost for competitive reasons.
Dumb article. Many dumb comments.
If you can agree that breaking windows and spending money on repairs (a keynesian wet dream) is retarded, how come spending money on flowers is better than spending money on a broken window, or better than spending money on gold?
Spending money on flowers, a broken window, or gold are all unproductive for the most part.
Now, had the flowers been genetically engineered clones using new technologies, if the window had been the latest gas filled insulating variety, or if the gold was worked into computer technology, phones, tablets etc. then perhaps you could claim that the spend was MORE worthwhile as a result of the expanded effects on the economy.
Thinking of it a different way: The more people employed gainfully, including energy and raw materials production, producing a product, the greater effect the purchase of that product has on an economy. No two products are alike, therefore the benefit pattern from a spend is unique. Just buying oil, gas, iron or gold doesn't have the same employment effect due to the gigantic economies of scale and limited skilled labour input these industries enjoy.
How much economic activity is created by Lance Roberts paying herohedge to promote crappy articles like this?
The gas station in his example is still going to make their same gross profits of ~$0.30/gallon regardless of what they are paying to Saudi Arabia/Russia/Canada/etc. for the raw materials.
I feel sorry for anyone who listens to the advice of a joker like this who is clearly demonstrating the economic savvy of a child.