The freefall in the price of oil over the second half of the year was one of the biggest economic developments of 2014. Brent crude oil dropped from around $110 per barrel last summer to below $60 per barrel by the end of the year — a fall of almost 50 percent.
Such a steep, rapid drop in oil prices has many effects on the global and U.S. economies. The most obvious effect seen by everyone is falling gasoline prices, which had dropped to a national average of $2.25 per gallon for regular gasoline by the end of the year, according to the AAA Daily Fuel Gauge Report. A year earlier, the national average for a gallon of regular gas was $3.31.
Who Wins, Who Loses?
So who are the winners and losers when oil prices fall this drastically? The most obvious winner is the average consumer who fills up the gas tank three or four times a month. For a family with two vehicles that must fill each 17-gallon tank four times a month, a one dollar per gallon drop in gas prices results in an annual saving of $1,632. This bonus is discretionary income that the family can spend on anything it wants.
This additional spending, in turn, helps boost the nation’s GDP. Each ten percent drop in oil prices boosts global GDP by an estimated 0.2 percentage points. Here in the U.S., it is estimated that lower gasoline prices could boost domestic GDP by 0.4 percentage points over the next year. Lower oil and gasoline prices also tend to keep inflation at bay.
When people have more money in their pockets to spend, this benefits a wide range of industries that sell goods and services to consumers. These include new home construction; home furnishings and appliances; home improvement retailers; healthcare; automobiles, RVs and watercraft; clothing manufacturers and retailers; providers of entertainment — basically, any type of business that sells things people do not necessarily need right now but tend to buy when they feel wealthier.
Airlines are another big winner in the current falling oil price environment. Not only are people more likely to splurge on air travel when they have extra spending power due to lower gas prices, but the airlines’ operating costs are significantly reduced, since jet fuel accounts for about one-third of these costs. With a strengthening economy and strong demand for air travel, airlines so far have not had to cut ticket prices, which is boosting their profitability after years of financial struggles.
Impact on Oil and Gas Companies
In general, most businesses benefit from falling oil prices because lower energy costs for everything from gasoline to electricity tend to boost their profit margins. One big exception to this, however, is oil and gas companies, since lower oil prices reduce their revenue and earnings. Worldwide, oil producers’ total revenue fell by a staggering $1.5 trillion in 2014.
Falling oil prices also have different effects on different countries. Russia and Venezuela, for example, are two of the world’s largest oil exporters. Oil and gas account for 70 percent of Russia’s export income, and the country loses $2 billion in export revenue for each one-dollar drop in the price of a barrel of oil. The World Bank predicts that Russia’s economy will shrink by at least 0.7 percent this year if oil prices do not bounce bank, and Russia’s Finance Minister has said that a recession this year is “inevitable” if oil remains priced in the $60 per barrel range.
Meanwhile, it is estimated that Venezuela loses between $450 million and $500 million in export revenue for each one dollar per barrel drop in oil prices. Venezuela was already dealing with serious economic problems before oil prices started falling, including soaring spending on social programs that racked up tens of billions of dollars in debt. It is estimated that the country needs oil prices in the $120 per barrel range to finance its anticipated spending in 2015.
Saudi Arabia, the largest exporter of oil in the world, is also highly susceptible to falling oil prices. However, it has built up an oil reserve fund of more than $700 billion, so it should be able to withstand the economic impact of low oil prices longer than most other countries that are heavily dependent on oil exports. In fact, as the most influential member of the Organization of the Petroleum Exporting Countries (OPEC), Saudi Arabia could boost global oil prices by cutting back production, but it has not chosen to do so yet.
Among the countries that could benefit the most from falling oil prices are those whose economies are heavily dependent on agriculture, since agricultural production generally requires more energy than manufacturing. This is one reason why poorer countries tend to benefit more than wealthier countries from falling oil prices.
Countries that are net importers of oil also stand to benefit from falling oil prices. For example, China is the world’s second largest net oil importer. For each one dollar per barrel drop in oil prices, China saves $2.1 billion. Cheaper oil could also help China clean up its dirty air by phasing out diesel fuels that contribute heavily to pollution. India, Europe and Japan are other net importers of oil that should benefit from falling oil prices.
Here in the U.S., oil production is at its highest level in three decades, thanks largely to the explosion of hydraulic fracturing (or fracking) techniques that extract oil from shale formations. The fracking explosion and resulting boom in U.S. oil production is one of the main drivers of the global oil price slump, since greater supply drives down prices.
As a result, the U.S. is now not only the world’s largest consumer of oil, but also the world’s largest oil producer and importer. Since we are a net importer of oil, falling oil prices should help the U.S. economy, on balance. It may also affect U.S. monetary policy, prompting the Federal Reserve to keep interest rates low for longer. However, falling oil prices could hurt the economies of areas that are heavily dependent on oil, such as Texas.
While fracking has been a major factor in falling oil prices, some energy experts are questioning whether or not oil production via fracking can continue at its current pace with oil prices so low. Fracking is a much more expensive way to extract oil from the ground than traditional drilling techniques, which means oil producers could actually lose money on each barrel of oil sold at rock-bottom prices.
One of Many Factors
The price of oil is just one of many different economic factors that influence both the global and U.S. economies and the performance of certain industries, businesses and nations. That being said, there are some clear economic winners and losers when oil prices are falling. This is something to keep in mind as you plan investing strategies for 2015 and beyond.