Each 1-cent drop at the gas pump = $1.4B in extra income. what’s not to love?
Monday Money Tip: Oil’s fall: Great for consumers, or the germ of ‘general contagion’?
Erin E. Arvedlund, Inquirer Staff Writer
POSTED: Monday, December 22, 2014, 1:08 AM
Ain’t it grand that oil prices are dropping? Yes and no.
For consumers, yes, the 40 percent drop, down to $55 or so per barrel, amounts to a massive income boost. Each penny drop in gas prices at the pump equals $1.4 billion a year in extra disposable income, according to Bill Dunkelberg, professor of economics at Temple University.
The best part, he says, is that American dollars aren’t leaving the country like they did in 2008, when $150-per-barrel oil enriched OPEC nations.
“Now we’re going to start collecting those oil revenues here when prices rebound,” he adds. “Money spent here stays here, as the U.S. is now one of the larger oil producers in the world.”
The marginal price of oil is too low, he estimates, as it costs about $65 a barrel for anyone producing oil.
“Demand will come back eventually. In the short run, this is great for consumers and should help the economy move along,” Dunkelberg adds. It has also likely prompted the Federal Reserve to keep interest rates lower for longer.
Other investment implications from the big move in oil prices?
Howard Marks of Oaktree Capital outlined some in a recent letter to investors (available at http://goo.gl/MUc547). He suggests:
With the cost of driving now lower, people might buy cars, benefiting auto companies.
Likewise, increased travel stimulates airlines to order more planes, a plus for aerospace companies. But there’s less incentive to replace older planes with fuel-efficient ones.
Reduced drilling leads oil-service companies to bid lower for business. That improves the economics of drilling, helping those oil and gas drilling companies.
Banks and other lenders may be hurt by their holdings of bad loans if things get ugly enough for their borrowers among oil and oil-service companies.
Marks cites views among Oaktree colleagues – though not by name – with one of them noting that energy is a significant part of the high-yield bond market. In fact, it is the largest sector today, bigger than media and telecom, the market’s traditional heavyweight. Energy is highly capital-intensive, and the high-yield bond market has been the easiest place to raise capital.
The “knock-on” effects of a precipitous fall in bond prices are potentially substantial: outflows of capital, and mutual fund and ETF selling, Marks and his colleagues say.
He quotes one colleague’s analysis: “An imperfect analogy might be instructive: capital market conditions for energy-related assets today are not unlike what we saw in the telecom sector in 2002.
“As in telecom, you’ve had the confluence of really cheap financing, innovative technology, and prices for the product that were quite stable for a good while. These conditions resulted in the creation of an oversupply of capacity in oil, leading to a downdraft. It’s historically unprecedented for the energy sector to witness this type of market downturn while the rest of the economy is operating normally. Like in 2002, we could see a scenario where the effects of this sector dislocation spread wider in a general contagion.”
Erin E. Arvedlund
Inquirer Staff Writer
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