Oil-price plunge: A historical perspective

In the summer of 2014, domestic spot oil prices hit a peak of $108 a barrel. They’ve been on a steady but irregular decline ever since. Currently, the spot oil price for West Texas Intermediate oil is roughly $30 a barrel. That’s the lowest price since 2003, and it represents a decline of nearly 75% from its summer 2014 peak.

To understand potential repercussions, we compared the current oil-price plunge to that of the 1986 drop (Display 1), because both price declines were driven primarily by an additional (unexpected or unappreciated) increase in available supply.

In September 1985, OPEC increased its oil production and lowered its price. At year-end 1985, OPEC members shifted from a policy of targeting prices to one of focusing on market share. In part, that policy change occurred because OPEC was worried about the increased oil supply coming from the North Sea. So, to thwart competition and keep its market share, OPEC lowered its price.

The additional supply catalyst in 2014 stemmed from an increase in US oil production—a direct by-product of shale technology. In fact, US oil production in 2014 had increased by 4 million barrels per day from 2010, thereby boosting domestic production to its highest level since the 1970s. As global prices fell, OPEC again sought to preserve market share and responded by maintaining current production. This surprised non-OPEC oil producers and investors, resulting in a plunge in oil prices that even the most pessimistic forecasts of 2014 did not anticipate from the outset.

Economic adjustments

Sharp and large downward changes in oil prices produce a string of economic adjustments, both negative and positive.

The most obvious negative adjustment is in the capital spending of energy companies. The sharp curtailment in oil-rig construction has resulted in a 50% reduction in nonresidential structures in investment in the mining and energy segment—a decline that’s roughly comparable to the peak-to-trough decline in 1986. However, the oil-price decline of 2014–2016 is larger than that of 1986, and there is no clear indication of when prices will bottom, let alone rise again. Consequently, we expect further declines in this investment segment.

On the flip side, the manufacturing-sector investment in new structures increased roughly 50% over the course of 2015, and now stands slightly above that of investment in energy-related structures (Display 2, next page). The last time investment in manufacturing structures exceeded energy-related investments was in the early 1970s.

Shifting consumer preferences

Disruptive changes have also occurred in consumer preferences. For example, in 2015, new vehicle purchases totaled 17.33 million. Albeit, that sales total fell just short of the record 17.35 million set in 2000. But purchases of trucks (light and heavy) did set a record. According to Ward’s Automotive, 10.3 million trucks were purchased last year, exceeding the prior sales total by 1 million and representing the highest tally ever (Display 3). Lower gasoline prices were a clear factor in the strong sales performance.

The shift in buying patterns toward lightduty trucks has pushed motor vehicle manufacturers to alter and rush their investment plans. Domestic firms as well as foreign transplants are adding billions of dollars to their investment plans in the US. The goal is to increase domestic production capacity for trucks, based on what they see as a permanent shift in buyer preference. This clearly reflects the view that oil prices will be low for a long period. And that influx of investment dollars will add to the strong uptrend already apparent in new structure investment by manufacturers.

Shifts in US consumer behavior are also evident in driving patterns. Total miles driven in 2015 reached a record level, and the increase in miles driven represents the largest annual gain since 1992. A more mobile consumer results in other spending-pattern shifts. For example, the greater use of a vehicle results in more wear and tear, which increases spending on maintenance and shortens the life of the vehicle. Also, spending on services such as eating and drinking away from home and domestic travel increased as well.

The sharp drop in oil prices plays a large part in overall pricing patterns and other disruptive economic changes, too. Businesses, with the greatest benefit flowing to transportation companies, consume as much energy/oil as consumers, so a sharp and permanent drop in fuel costs can motivate firms to upgrade their fleets, as well as pass along the windfall to shareholders, workers or customers. It’s hard to say at this juncture with any certainty how energy-consuming firms will spend the windfall, but it is an accumulating benefit and hugely positive to the broad economy.

How low? How long?

How deep oil prices plunge and how long they remain low have important implications for monetary policy. Policymakers have been arguing that the oil-price decline is a temporary phenomenon: as prices flatten or stabilize, headline inflation will start to move up, more accurately reflecting current trends in core prices, which increased 2.1% in 2015 (according to the Consumer Price Index).

Yet the sharp oil-price plunge in just the first few weeks of 2016 further delays any rebound in headline inflation. And since several policymakers raised concern over the inflation outlook at the December Federal Open Market Committee meeting, it’s quite possible that policymakers could signal a delay in the rate normalization policy at next week’s meeting.

All in all, we tend to view an energy-price decline as a net positive for the economy over a 12- to 18-month period. Yet the initial negative impacts tend to outweigh the positive—so growth and inflation could be about 0.5 percentage point below our forecasts for 2016 if oil prices remain at current levels through the end of the first quarter.

By Joseph G. Carson, US Economist and Director, Global Economic Research, AB

———

The information contained herein reflects the views of AllianceBernstein L.P. or its affiliates and sources it believes are reliable as of the date of this publication. AllianceBernstein L.P. makes no representations or warranties concerning the accuracy of any data. There is no guarantee that any projection, forecast or opinion in this material will be realized. Past performance does not guarantee future results. The views expressed herein may change at any time after the date of this publication. This document is for informational purposes only and does not constitute investment advice. AllianceBernstein L.P. does not provide tax, legal or accounting advice. It does not take an investor’s personal investment objectives or financial situation into account; investors should discuss their individual circumstances with appropriate professionals before making any decisions. This information should not be construed as sales or marketing material or an offer or solicitation for the purchase or sale of any financial instrument, product or service sponsored by AllianceBernstein or its affiliates. This document has been issued by AllianceBernstein Australia Limited (ABN 53 095 022 718 and AFSL 230698). Information in this document is intended only for persons who qualify as “wholesale clients,” as defined in the Corporations Act 2001 (Cth of Australia) or the Financial Advisers Act 2008 (New Zealand), and should not be construed as advice.

The post Disruptive effects of oil-price plunge appeared first on AdviserVoice.