Plunging oil prices are a leading indicator of what?
Crude oil prices have been plummeting since June, as markets have been assessing weaker emerging market countries’ demand and the prospects for more Iranian crude oil supplies. By August 20, the price of West Texas Intermediate (WTI) oil plunged to $41 per barrel vs. its 2015 daily peak of $61 two months earlier.
What difference does this make for domestic US economic prospects? At times, Fed Chair Yellen has cited lower energy prices as a net plus for the US, which remains a net oil importer, albeit not as much as in past years. However, equities markets seem to be taking the opposite viewpoint, seeing lower oil prices as a net negative economic consideration. That said, we still evaluate lower oil prices as essentially “a wash” for the US economy, with benefits approximately offset by domestic energy patch doldrums.
The case for lower oil prices being stimulative is that lower energy costs raise real (inflation-adjusted) purchasing power. However, how much of that purchasing power will flow into higher expenditures outside of energy? That depends on who is receiving the benefits of those lower costs. In the household sector, around 56% of gasoline was consumed by the top two-fifths of income distribution last year. For these relatively more affluent families, gasoline prices and expenditures are not apt to be a pivotal non-energy spending determinant.
Nevertheless, there is more likely to be a positive spending effect on the bottom three-fifths of income distribution, who account for around 44% of gasoline expenditures.
The argument for lower oil prices depressing the economy hinges on the US becoming more self-reliant on domestic energy sources. While energy extraction accounts for less than 1% of the level of GDP, very large changes still can have a noticeable impact on annualized real GDP growth. Consider the related “mining, exploration, shafts and wells” component of GDP. On a real (inflation-adjusted) basis, it subtracted almost 50 basis points from annualized overall real GDP growth in Q1, followed by an even larger subtraction of around 70 basis points in Q2.
However, notably, so far in Q3, there has been a tentative stabilization of the domestic rotary drilling rig count, which is well correlated with the energy exploration component of GDP. Also, the Federal Reserve Bank of Dallas’ contribution to the Federal Reserve’s July Beige book on regional business conditions stated that massive layoffs in the energy sector had largely concluded.
There are a couple of techniques for gauging the net effects of these cross-currents. One way is to compare current dollar National Income Accounts (NIA) data on households’ gasoline expenditures with the energy exploration component of GDP. From Q414 to Q215, gasoline expenditures, on balance, fell by $53.5 billion vs. a $57.3billion drop in the energy extraction component of GDP. From this perspective, oil price changes have been close to a “wash” for the US economy.