Timing, as they say, is everything. And Illinois’ entry into the fracking game seems to…
There are a lot more smiles at the gas station lately, as consumers enjoy the lowest gas prices in six years.
On Wall Street, however, there are a few more frowns as investors try to figure out what’s behind the drop and what it might mean for the economy in the long run.
In and of itself, the drop in oil prices is a positive development, says NIU Professor of Finance Gerald Jensen, an expert in monetary policy and investment management. “As long as you’re not an oil company, it’s good news,” he says. “For just about everyone but oil companies, petroleum products are an input, a cost of doing business. So, when that cost goes down, businesses win and consumers win.”
Some of the biggest winners, he notes are companies like UPS and FedEx which operate enormous fleets of trucks and airplanes, which have suddenly become much less expensive to operate.
In December, expects estimated lower gas prices would save the average US family $500 over the course of the year (the equivalent of a $60 billion tax cut) and prices have only continued tumbling since then. The travel industry — from airlines to amusement parks, to hotels — is expected to be one of the biggest beneficiaries as Americans use that windfall to hit the road. That is why, Jensen believes, that the Cracker Barrel restaurant chain, which has franchises located along interstates across the country, has been a favorite on Wall Street in recent weeks.
Ultimately, he says, the drop in oil prices will start to show up in other areas, such as the grocery story, since gasoline prices are a huge part of food production and delivery costs. All of that is good news for consumers.
For investors, however, it’s not enough just to enjoy cheaper gas; they want to know what is behind that drop in prices? Not surprisingly, there are several answers to that question, and not all are favorable.
- Rising Supply – Thanks to new technologies, like fracking, oil production in North America has soared in recent years. In 2014, the U.S. produced 11 million barrels of oil a day, surpassing both Russia (which was producing at its highest levels since the post-Soviet era began) and Saudi Arabia to become the world’s leading producer. The glut has been further exacerbated thanks to Iraqi oil fields that are now producing at levels not seen since the 1980s and Libyan oil fields that are starting to come back on line after a year of civil unrest shut down operations there. Basic economics says more oil means lower prices, which, on its own would be good news. However, there is also…
- Falling Demand – While production has soared, demand has decreased. In December, OPEC projected that demand for oil in 2015 will be the lowest in 12 years. The reason for that drop is what concerns traders – specifically the slowing economies of China, Germany and now Russia, where the government depends upon oil prices at about double current levels to generate enough revenue to keep its budget balanced). “When major economies falter, uncertainty creeps into the market, and the markets hate uncertainty,” says Jensen.
- Political Instability – The economic instability spawned by plummeting oil prices has wreaked havoc in places like Iran, Venezuela and Russia, all of whom find their bargaining position with the U.S. and its allies severely undercut. While this can be good for the U.S. politically, it also increases chances of revolutions, rioting and military posturing which in turn creates more of the uncertainty that makes traders so nervous, in turn driving prices even lower.
- The strong dollar – Economic uncertainty around the globe has increased the value of the dollar (in 2014, the Russian ruble declined in value by more than 50 percent versus the dollar, while the yen and euro lost 10 percent). Because oil is priced in dollars, that means you can buy more oil for fewer dollars, further driving down the price, explains Jensen. However, since the growing strength of the dollar is due more to weakness elsewhere than to a robust economy at home, that too is not the good news it would seem.
While all of those things are contributing to the drop in oil and gas prices, and to an overall skittish market, none of it weighs on the minds of investors like trying to figure when the Federal Reserve will begin raising interest rates.
“We have had a lot of monetary stimulus for the last several years, and the economy improved, but not nearly to the extent one might have expected,” says Jensen. “You can’t continue to do that forever, and traders are wondering what will happen when the Fed starts tightening policy. I think that’s the biggest factor that markets are looking at.”
In the meantime, Jensen says, the price of oil will find its level, and likely one that is significantly lower than it has been in years. That will put more money in consumer’s pockets, meaning that they will spend more and that is almost certainly a positive for the economy.
“Overall,” says Jensen, I believe that low oil prices will be good for the markets.”
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