Oil Price Drop: Bad News and Faulty Inferences

I’m not much of a macro guy (my specialty is firm strategy), and I do not pay too much attention to oil prices. After all, I live in NYC, so I don’t drive all that much. Further, I rent, so I don’t have to think too much about the cost of heating, cooling, and powering my apartment.

Not only that, but in some ways, I would almost prefer oil cost $1,000 per barrel. I don’t mean to be cavalier about that. It’s not because I feel like we should stick it to the little guy, whose life depends so much on the availability, and use, of oil. I get that, and I understand how much strain high oil prices have caused to the economy. However, my view is that $1,000 oil would incentivize us to find an alternative to fossil fuels, …and quick.

My philosophical bent is that we need to find, and encourage, alternatives to fossil fuel-based energy, for the end of our dependence on oil (foreign or domestic) can’t come quickly enough. It is my hope that we can reverse the degradation that years of carbon pollution has caused to our environment for the sake of future generations.

Now you know my bias.

But given that information, what do I make of oil’s precipitous drop from nearly $150 to $120?

Frankly, I think many who have made inferences in the wake of oil’s drop have gotten it wrong. I’m tired of hearing what a wonderful thing it is for our economy that the price of oil has been going down - as if it will cure all our ills and will help us avert a recession. Analysts have used this to explain why the market has gone up in recent days. For example, as reported just yesterday by Yahoo! news (see Stocks Advance Following Sharp Drop in Oil Prices):

Investors expect that a sustained pullback in oil prices would give a crucial boost to the economy.

Hogwash!

People are confusing cause and effect. People are buying into the story that lower oil prices causes increased economic activity. In normal times, sure. I buy that. However, in my opinion, this is not what has caused oil’s recent slide, nor is it what will likely drive oil’s continued decline in price (barring escalation of geo-political tensions in Iran, Nigeria, etc.).

What has caused oil to tumble is a drop in demand. Plain and simple.

American consumers are obviously in a bad way (see Rising Household Debts, Defaults Straining US Economy). My view is that we are currently in recession. During recessions, demand for a whole host of goods drops, oil included. But now that much of Europe is in, or near, recession (see Roubini’s excellent post on Global Recession Watch), European demand for oil (and other goods) is waning as well. Add the double-whammy of recessionary US and European economies, and it becomes obvious why the price of oil has dropped.

So the erroneous inference is that decreased oil prices will lead to increased economic activity. The correct inference is that decreased economic activity has caused a drop in the demand for oil, which causes oil prices to drop.

The drop in oil prices is therefore neither good news for the US economy nor Europe’s economy; but rather, bad news that indicates just how fragile those economies have become.

Comments

[chrome]

Well the substance of your article is right on. Stick with the issue on this very serious problem and perhaps you might add a remedy or two that might help bring this to the conscious mind of all your readers. You could do this in place of all the fluff you found necessary to explain to us about your personal situation. My Mom used to say if you don't mean to be cavalier...Then don't be.

[calvino]

I will up your ante. The oil drop back is a counter attack on Boone Pickens. The oil boys and all that suck on that teat became concerned when an oilman said alternative energy is the future.

[rdr4]

I agree with the cavalier assessment, do you consume food? anticipate an increase in rent based on energy costs? notice an increase in almost every product available that is delivered by trucks?

Hard to take the info in the article seriously after such a personal rant.

[User 217857]

One of your errors in thinking is the same as many: you think the price of oil on an international basis is solely affected by what happens in the United States. The world of economics is no longer U.S or Euro-centric.

[chrome]

I'm sorry I didn't put my name (209695) to my comment that heads this comments section. I'll put my name behind anything I say.

[RJ1965]

I THINK YOU HIT IT ON THE HEAD IN THE 6TH PARAGRAPH I ALSO AM TIRED OF OIL BEING THE BLAME FOR EVERYTHING.... AND OH MY GOODNESS OIL DROPPED WERE GOING TO BE OK!!!..... PLEASE...YOUR ARTICLE IS RIGHT ON.

[CJ-49]

I have all the due respect for you as a person but if I may say so you represent most OECD working persons who are so integrated into an economic cocoon that they have little concept of the reality around. And so you go on about BS like climate change and how it is 'destroying the world' (?) Newsflash: It's NOT any more than the climate has been. And $1000 crude?? Give me a break. You and your ilk have no sense of the huge numbers out there who were already on poverty levels and are now silently eating less and living less well than they were because of the oil scammers in NYC. As I said, with all due respect. And get this. 1. The world does not consist entirely of NYC. 2. The rest of the world is certainly not the BS CNN, CNBC et al force feed down your throat to maximize their advertising revenue.

[John Egan]

Correct... Get used to high energy prices. This is a pullback. And although I like T. Boone, lets face it, he's really just pushing his latest investment. Ignore the 'Aw shucks' attitude and you have a pretty canny investor. (Remember how Luke Skywalker's impression of Yoda was incorrect, and you'll get my drift..). But, he's right! Wind, solar and geothermal are our future. Also. lets dump the corn based gas program, cancel the government's tax support for these programs and for ethanol type corn growing (sorry Archer Daniels...), cancel the tariff on imported ethanol and cozy up to Brazil.

jegan ;-)

[MichaelC]

Oil makes the current world go around economically. We have national economy problems becasue of the increase in the cost of oil AND the credit problems from the housing market. If only one of these influences were hurting our economy now, the problems wouldn't be nearly as bad. The price of oil has many complex issues impacting it, including demand. When demand substantially decreases, so will the price of oil. The oil companies make less money (but they make money!) and then consumers begin to have more money to spend. That's when the consumer factor strengthens the economy. I worked for Conoco 30 years ago when oil was less than $10/bbl, we thought $12-15/bbl would, if done in a few months, ruin our economy. You can't imagine how important oil is to our economy and the rest of the world. Please remember that oil eventually makes plastics, soaps, detergents, pesticides, herbicides, drugs, perfumes, oil additives (products that make "your" product better), nylons, PVC, tires, and a bizillion other applications. Also, oil makes energy products like gasoline, etc., etc. It might be a bit easier to try and find a commercial product that isn't based on carbon from oil. Our economy depends on making and selling products to the masses of people around the world. When the price of oil gets too high, the people will not buy and/or they cannot buy. I'm trying to get you to understand the incredible impact of the price of crude to our economy. Ask yourself this: "What impact on our economy would take place if the price of crude fell overnight to $50/bbl and stayed there for three years?" What impact would this have on our economy, even in the presence of the housing credit problem? Apparently, our government seems to think that they can significantl help with the credit probles and the banks. How much can our government help to control the price of crude oil?

[chrome]

Forgive me but we need to move now. As Picken's says everything is on the table but let's go.

I could care less if he makes 100 Billion dollars off of his ideas. Lets go.

Like it or not oil is the only issue of the day.

You think oil prices are a problem now you ain't seen nothing yet.

If we can't transport our goods, be gainfully employed and provide for our family's...Has anyone hurd of "Great Depression".

[BrianPursley]

No such thing as "fossil" fuel: oilismastery.blogspot..../

The only alternative to hydrocarbons is human stupidity.

[User 233152]

"I get that, and I understand how much strain high oil prices have caused to the economy"
"The drop in oil prices is therefore neither good news for the US economy nor Europe’s economy"

What?

I do see a desperate need for alternative energy, but not at the expense of your so call "little guy". Right now the "little guy" can barely afford to drive to work (which most of us do outside that relatively tiny area of NYC), never mind spending money on nonessential things that would help the economy. Gas price drops, I believe, would be a DRAMATIC boost to the economy. Though I think you intended to voice your opinion on the long term economy, I just don't see by raising the prices on almost everything now helps in the short or long term.