The swift drop in oil prices in recent weeks may have motorists cheering, but the financial world is in a tizzy over whether there is a larger meaning behind the shocking plunge in the commodity that greases the global economy.
“The thing you have to worry about when you have a precipitous drop like this is it could be signaling bad things for everybody,” said Phil Flynn, senior market analyst at Chicago-based Price Futures Group. “That’s the big concern.”
American motorists are saving about $80 million a day, thanks to a 20-cent-a-gallon drop in the price of regular gas since Oct. 1.
Business also like lower oil prices. But if companies think the decline portends an economic slowdown, they may rein in spending and hiring. Those fears can develop into recession.
The long-running bull market is already under pressure from the Federal Reserve’s raising interest rates, from tariffs between the United States and China, and from a sell-off in technology stocks.
Continued pressure on oil prices could drag stocks even lower.
Stocks declined again Wednesday, with the Dow Jones industrial average dropping 205 points. The blue-chip barometer is 7.48 percent off the all-time high it reached Oct. 3. The Nasdaq composite is down 12.7 percent from its Aug. 30 peak. The S&P 500 is 8.7 percent below its Sept. 21 record.
Flynn rated the six-week oil-price pullback “a minor bust.”
Benchmark Brent Crude and West Texas Intermediate both saw price increases Wednesday, snapping a 12-day losing streak. Brent was $65.70 per barrel, up 0.41 percent on the day. West Texas Intermediate closed at 55.86, up 0.36 percent. Both are down more than 20 percent from their highs in early October.
The magic number is $50 per barrel.
“We are clearly in the danger zone,” said Frank Verrastro, a global-energy expert at the Center for Strategic and International Studies. “For U.S. producers, sustained prices below $50 would undoubtedly be problematic for all but the most efficient operators.”
The International Energy Agency two days ago issued a report that trimmed its forecast for oil demand growth in 2018 and 2019, citing weaker economic outlook, a slowdown in China, trade concerns and higher oil prices.
Several experts echoed Flynn, saying that the current oil price pullback is temporary and that they expect Brent and WTI to settle in a range of $50 to $80 in the longer term.
“That is the band where neither consumers nor producers are hurt,” said Bob Tippee, editor of Oil & Gas Journal. “There is somewhat of a swoon right now. This is the kind of gyration that is part of market psychology. The market is softening. Demand growth has slowed.”
Energy analyst Pavel Molchanov of Raymond James sees oil prices toward $100 a barrel by 2020. “The big picture is very bullish,” Molchanov said.
The current surplus is largely attributed to a miscalculation between demand and output by major producers, including Iran. A strong dollar is also weighing on oil prices because it makes oil more expensive for much of the world. Oil prices tend to fall as a result.
Oil is a boom-and-bust business. The price drops when supply exceeds demand. Producers pull back and slow production as a result of the price squeeze. When demand exceeds supply, producers start drilling again and the cycle picks up again.
The rub is the length and depth of the down cycle. The Houston oil crash of the 1980s after a collapse in prices is often cited for its severity. It flattened the city’s economy, vaporized more than 200,000 jobs, emptied office buildings and wreaked havoc in the financial sector. The region’s recovery took years.
The United States is the world’s biggest oil consumer at about 21 million barrels a day of the 100 million barrels produced daily worldwide. It is also a top oil producer, thanks to the shale oil renaissance over the past half-decade.
Oil and gas represent about 7.6 percent of U.S. GDP. Low prices have a salutary effect across the economy, including moderating the rate of inflation. By helping to keep inflation low, low oil prices can stem the rise of interest rates, including for mortgages and auto purchases.
“Energy costs have a pervasive impact across the entire value chain of the U.S. economy,” said Dean Foreman, chief economist for the American Petroleum Institute.
Some worry that the current cycle could be a replay of 2014 through 2016. Starting in mid-2014, oil prices began falling, moving from $80 per barrel into the $20s after oil giant Saudi Arabia drove down prices, thereby squeezing U.S. producers.
“It was a major crash signaling a slowdown in the global economy,” Flynn said. “We had Brexit, a slowdown in Europe. Big Oil had some of their worst years ever.”
Exhausting the oil surplus took producers years of disciplined production limits. Only in the past year or so did prices recover to a level where producers could make healthy profits without incurring the wrath of consumers.
The good news is that pump prices have dropped 20 cents in the past six weeks, from $2.88 per gallon for regular gas to $2.68, according to AAA.
That saving is fattening consumer pocketbooks as the holiday season approaches. Dollars that would have gone to oil and gas companies will instead be spent at retailers such as home repair giant Home Depot, department store Macy’s, restaurants and hotels.
“Today the national average is about 30-cents less than the summer’s highest pump price,” said Jeanette Casselano, a spokeswoman for AAA. “Combine that savings with the sustained strong economy, and Americans will have more change in their pocket to spend around the holidays.”