Was Last Week's Collapse of Oil's Price a Blessing or a Warning?
Take your pick regarding the meaning of last week's continuing dramatic collapse of the price of oil: blessing or warning.
The "blessing" camp sees the reduced price as a "tax cut" for the American people. Since most of us use cars to get around, and need gasoline - a product of oil - to run our cars, a lower price keeps more money in our pockets. However we note that this camp divides between those who believe the consumer will spend this extra money, and those who hold that rather than spend, consumers will pay down debt and/or save their money. Of course, reason dictates that people could also combine spending and saving, killing two birds with one stone, as the saying goes. Time will tell...
Unless, of course, the "warning" camp turns out to be right. These folks see the oil price collapse as an expression of trouble for many of the world's economies. And trouble is spelled with an "R" as in recession, or at the very least significant slow down. A slow down would cause demand for oil to drop, and supplies to increase.
So how do we pick between the blessing camp or the warning camp? Who's right? Let's see where our power of reason takes us.
We know that the whole fracking phenomenon in the U.S. has indeed increased world oil supplies. With U.S. production increasing dramatically due to fracking technology, the only way supplies can stay the same is if production from other sources decreases. That hasn't happened. In fact, a couple of weeks ago, Saudi Arabia - the world's largest producer - publicly announced it had no intentions of cutting back on production, even in the face of falling prices. Immediately, the price of oil dropped over 5%. It shocked many of the world's markets.
With our knowledge of rising supplies, we turn to demand. Demand may not be increasing enough to absorb increased supply. But what if demand is also falling, as supplies increase? Here the evidence isn't as clear. We do, however know this:
Our conclusion at the moment must be that, while we know that supplies have increased, there's not enough evidence to determine whether those supplies account for the drop in oil prices we now see. We must keep an open mind and consider the possibility that not only an increase in supply but also a slow down in the global economy accounts for this fall in oil prices.
One thing we should watch out for is any snap back in the price of oil. The dramatic fall we've seen "should" lead to a correction of some sort, at some point. If the price turns around, will it be because oil has bottomed, or will that turnaround be a natural correction in a downward trend? We simply don't know now, and won't know if the price turns around - at least at first.
Don't be surprised to see the price of oil continue to drop. Don't be surprised if a reversal in this trend turns out to be a natural correction in an ongoing down trend. We await further evidence before passing any judgement.
Whatever happens, filling up our tanks won't be as much of a financial burden. This we do know. But even here, the price of gasoline really hasn't fallen as much as some make it out to be. When Obama took office in 2008 - a mere six years ago, it was, on average, lower than the today's price.
So with all this in mind, let's not jump up and down over the "low" price of oil. After all, the price of gasoline is only now approaching what it was when Obama took office six years ago. And let's not jump to any conclusions about a lower oil price translating into dramatically increased economic activity due to consumer spending: consumers may instead pay down debt, or - heaven forbid - save more.
Finally, let's not conclude that recession lies in the immediate future here in the U.S. On the other hand, we wouldn't discount the possibility that, while perhaps not an immediate prospect, a recession may be lurking somewhere out there in the not-too-distant future.
The "blessing" camp sees the reduced price as a "tax cut" for the American people. Since most of us use cars to get around, and need gasoline - a product of oil - to run our cars, a lower price keeps more money in our pockets. However we note that this camp divides between those who believe the consumer will spend this extra money, and those who hold that rather than spend, consumers will pay down debt and/or save their money. Of course, reason dictates that people could also combine spending and saving, killing two birds with one stone, as the saying goes. Time will tell...
Unless, of course, the "warning" camp turns out to be right. These folks see the oil price collapse as an expression of trouble for many of the world's economies. And trouble is spelled with an "R" as in recession, or at the very least significant slow down. A slow down would cause demand for oil to drop, and supplies to increase.
So how do we pick between the blessing camp or the warning camp? Who's right? Let's see where our power of reason takes us.
We know that the whole fracking phenomenon in the U.S. has indeed increased world oil supplies. With U.S. production increasing dramatically due to fracking technology, the only way supplies can stay the same is if production from other sources decreases. That hasn't happened. In fact, a couple of weeks ago, Saudi Arabia - the world's largest producer - publicly announced it had no intentions of cutting back on production, even in the face of falling prices. Immediately, the price of oil dropped over 5%. It shocked many of the world's markets.
With our knowledge of rising supplies, we turn to demand. Demand may not be increasing enough to absorb increased supply. But what if demand is also falling, as supplies increase? Here the evidence isn't as clear. We do, however know this:
In March, many analysts predicted global demand for crude oil would grow by 1.4 million barrels a day in 2014, to 92.7 million barrels a day.With our knowledge that demand has not increased as much as once believed, what we need to watch now is whether demand is actually slowing significantly. This would push us into the "warning" camp.
That prediction proved wildly optimistic.
Our conclusion at the moment must be that, while we know that supplies have increased, there's not enough evidence to determine whether those supplies account for the drop in oil prices we now see. We must keep an open mind and consider the possibility that not only an increase in supply but also a slow down in the global economy accounts for this fall in oil prices.
One thing we should watch out for is any snap back in the price of oil. The dramatic fall we've seen "should" lead to a correction of some sort, at some point. If the price turns around, will it be because oil has bottomed, or will that turnaround be a natural correction in a downward trend? We simply don't know now, and won't know if the price turns around - at least at first.
Don't be surprised to see the price of oil continue to drop. Don't be surprised if a reversal in this trend turns out to be a natural correction in an ongoing down trend. We await further evidence before passing any judgement.
Whatever happens, filling up our tanks won't be as much of a financial burden. This we do know. But even here, the price of gasoline really hasn't fallen as much as some make it out to be. When Obama took office in 2008 - a mere six years ago, it was, on average, lower than the today's price.
So with all this in mind, let's not jump up and down over the "low" price of oil. After all, the price of gasoline is only now approaching what it was when Obama took office six years ago. And let's not jump to any conclusions about a lower oil price translating into dramatically increased economic activity due to consumer spending: consumers may instead pay down debt, or - heaven forbid - save more.
Finally, let's not conclude that recession lies in the immediate future here in the U.S. On the other hand, we wouldn't discount the possibility that, while perhaps not an immediate prospect, a recession may be lurking somewhere out there in the not-too-distant future.
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