Paul Hodges looks at the likely longer-term implications of the fall in oil prices
The chart shows this process taking place in respect of the US benchmark oil, West Texas Intermediate (WTI, blue line). Its price has been divided by 6, to take account of its relative energy value versus natural gas (red). And as I have discussed in my ACS Chemistry & the Economy webinars, the chart also highlights developments since 2002. This was when oil and natural gas markets first began to be impacted by the US Federal Reserve’s aim of creating a ‘wealth effect’ that would lead to increased consumer spending, and so support economic recovery:
- The first impact was seen post 2002 as the Fed cut interest rates to create a ‘wealth effect’ in the housing market. This created the phenomenon of mortgage equity withdrawal, and an average $564bn/year of additional consumption. In turn, this artificially raised demand for both oil and gas, causing prices for both to rise, before ending with the sub-prime disaster of 2008
- The second impact since 2009 has involved the Fed in directly boosting stock market prices via the printing of electronic money, or “quantitative easing”. As then Fed Chairman Ben Bernanke explained in November 2010:
“Higher stock prices will boost consumer wealth and help increase confidence, which can also
spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle,
will further support economic expansion”
But fewer Americans own stocks (52%) than own houses (65%). And so, predictably, oil markets are confirming, as in H2 2008, that a Great Unwinding of this second stimulus program is now well underway. It has helped to create an energy glut, with the International Energy Agency warning recently that oil markets are seeing an “historic shift”.
What does this mean for ACS members? One obvious impact is lower gasoline prices. Another, less favourable, is that a wide range of companies connected to the oil sector are laying-off workers. Research by the Manhattan Institute and the Wall Street Journal has highlighted how the US oil/gas boom has been central to the recovery in US employment levels since 2009. Housing starts will likely also decline, as the flow of job migrants reverses.
I do not expect another 2008-style Lehman Brothers collapse. As Mark Twain wisely noted, “history repeats itself, but it doesn’t rhyme”. Instead, I believe the oil price collapse itself, and its wider impacts in financial markets, will trigger sustained deflation. This will effectively reverse the oil price inflation shock of 1973, when rising BabyBoomer demand created massive supply shortages.
Demographics, of course, have been the underlying cause of both developments. Today’s ageing Boomers no longer need, or can afford, to maintain their previous levels of demand. Cash will no longer be “trash”, as we came to believe after 1973. Instead, its value will rise day-by-day, as will the cost of debt. I will analyse other likely impacts of this historic development in future blog posts.
Paul Hodges is chairman of International eChem (www.iec.eu.com), trusted advisers to the chemical industry and its investment community. He is a member of the World Economic Forum’s Industrial Council on chemicals, advanced materials and biotechnology, and presents the ACS ‘Chemistry & the Economy’ webinars.