Lower Fuel Costs – What’s Good and What’s in Doubt?

By Gary Wartik
January 29, 2015

Since November 2014 there has been significant discussion about the short and long-term effects of dramatically lower vehicle fuel prices on the American economy, and even on the world economy. From this vantage point, it looks positive in the shorter term, but with some caveats.

Under current pricing, a hypothetical California family that drive vehicles that get 25 miles per gallon, and purchase an average of 75 gallons monthly at $2.35 per gallon, will save about $100 a month, when compared with the average price of $3.70 per gallon in place just last fall in Southern California. That annualized savings of $1200 is important to many families and certainly to the local economy. Some families will have the discipline to put the funds into savings, or into reducing debt, while others will intentionally or otherwise spend the savings in the local economy. Those actions are all a good thing.

From the standpoint of businesses, a reduction in fuel costs will have many levels of benefits, most apparent of which is the reduction in all costs associated with the delivery and shipping of everything from raw materials to finished products. With fuel costs held in check for the time being, companies may find greater profits for shareholders, and even spread some of the savings in the form of improved employee wages and benefits. United Parcel Service, FedEx and moving companies, for example will save thousands of dollars daily that can either be passed along to customers, or that will serve to hold delivery rates in check. Major companies such as commercial airlines will benefit from the savings that will flow right down to the bottom line. In effect, lower fuel costs will help hold future inflation in check. These are good things too.

In another other realm of good news, the 50 percent drop in international oil prices during the last few months has begun to hurt some neighborhoods that are less than friendly to America. Think Russia, Iran and Venezuela. These three states mainly fund their national budgets with oil money. There are likely few tears being shed around the Western world for the economic challenges now faced by these autocratic regimes.

What is helpful to understand, however is that there is no “free ride” for many. Lower oil prices also affect our own economy, as well as some of our important allies. Canada, Mexico, the United Kingdom, Norway and some West African oil exporters are also going to suffer budget impacts. Fortunately for most of them, these countries have more diverse economies that are less dependent on oil exports.

Here in the United States, we have a number of states that are major oil producers. Texas, North Dakota, California, Alaska and Oklahoma are the top producers, in that order. Each looks to strong oil revenues to maintain a healthy economy. In the area of “be careful what you wish for,” there are already news reports of thousands of job layoffs in the American oil industry itself, along with those that service that industry. We are already seeing layoffs in Texas, North Dakota and in the Bakersfield, CA area. There are more to come. The job layoffs are not good news, although if one compares the value of wages lost versus the overall gains of fuel savings in the economy, lower oil prices clearly win out. The challenge is that if you are one of those losing a job, that puts one in a crisis mode. That is not good.

Recent press reports reflect that even with low fuel prices only in place for a few months, some Americans are already thinking that fuel efficiency and conservation are now less important. The increase in the purchase of larger, less fuel efficient vehicles in the US has already been reported, as has a decrease in consumer interest in fuel efficient vehicles. This sends the wrong message to our fellow citizens and to the world. This is not a good thing.

There is one more aspect to the oil price issue that warrants addressing. That relates to OPEC, Saudi Arabia in particular. The press has been replete with reports that the Saudis are looking to maintain market share at almost any price. Their $750 billion in dollar reserves confirm that they can afford it. Some Saudi officials have been candid enough to admit that they oppose America’s move towards energy self-sufficiency. This is not good for OPEC, and if the Saudis drive the oil price down further, it may be a challenge for America as well.

It is no secret that the advent of American shale oil extraction, where previously uneconomical to recover, is now a significant threat to OPEC. If the goal of the Saudis in particular is to drive oil prices down low enough to make the more expensive process of fracking for shale oil uneconomical, then over a period of time, less oil will be available on the world market. Oil prices will then begin to rise again. As well, the faster the economies of Germany, India, Japan, and China recover from their respective reduced economic growth, the faster additional consumption may drive up international oil prices.

From the macro point of view, $46 oil is likely not sustainable long term. Prices may dip some more, but the sense here is that prices will begin to firm as the economies of the industrialized nations begin to recover from their present malaise, perhaps later in 2015. That too would be a good thing, even if that drives oil prices somewhat higher.

We won’t know for awhile how much the oil markets have changed. Markets will remain subject to political shocks, especially in the Middle East, but new American oil coming on line, whatever the international shocks may be, should lessen the impact on world oil prices than they have previously. That should be a good thing too.

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