The recent decline in oil prices is considered a gift in the form of a hidden tax cut for the consumer. Because people are spending less at the pump, they now have more money to spend on other goods. Due to the decline in energy costs, businesses have more money to invest in other areas, thus allowing their businesses to grow and expand, at an even faster rate. Part of this is true, but what this conclusion fails to recognize is that this isn't the 1990s, or the early 2,000s; the economy has changed. What I want to present to you is the downside of low oil prices for America, and the economic growth that will become undone.
Over the past couple of years, the state of Texas has outperformed the overall US economy. In 2012, Texas was ranked as the number one state for job creation; and from 2009-11 the state of Texas created 49 percent of all the nation's new jobs. This year again, Texas is now estimated to be the top job creating state in America. In fact, Texas is expected to create 480,000 new jobs this year, which would be the second highest growth rate for a single state ever, trailing only California in 1978, when California created 600,000 jobs that year. Most of these jobs created in Texas, were created directly and indirectly from the shale oil boom.
It isn't just Texas that has benefited from the shale boom. When it comes to the largest increase in job growth from a percentage standpoint, that title belongs to North Dakota, not Texas. But it isn't just North Dakota and Texas that have benefited from this boom; the whole US economy has benefited as well. Since 2007, the number of oil and gas jobs in the United States has increased by 40 percent; the oil and gas sector is growing much faster than total private sector employment, and the jobs associated with the oil and gas sector are generally high paying jobs. In 2013, the oil and gas sector paid an average wage of $103,400, which is 108 percent higher than the average wage of a private sector employee. Half of these jobs are in the drilling sector of the oil and gas industry. Not only did this shale oil boom create jobs, but it decreased the trade deficit as well; in fact, Ben Bernanke credited the shale oil and gas boom as one of the most meaningful developments since 2008.
According to the Bloomberg graph above, 19 shale regions in the US are unprofitable when the price of oil is below 75 dollars per barrel. In fact, US drillers have recently abandoned more rigs than they have had in the last two years, due to low oil prices. In fact, some companies are now laying off employees because of this price decline; Halliburton (NYSE:HAL) has already laid off 1,000 employees, Enbridge (NYSE:ENB) has cut close to 100 positions and is instituting a hiring freeze once current open positions are filled. BP (NYSE:BP) has announced it will accelerate its job cuts. Hercules Offshore (NASDAQ:HERO) has sent notice that mass layoffs are on the horizon, Oasis Petroleum (NYSE:OAS) has announced it will cut its capital budget nearly in half, and ConocoPhillips (NYSE:COP) has reduced its capital spending budget by 20 percent for the year 2015. As you can see, if these low oil prices persist, a lot of good paying jobs will be lost in the US, as oil production decreases. I also want to point out, when the energy sector is laying off people and curtailing production, what will happen to America's trade deficit. In my opinion, I think it's obvious; the trade deficit will increase again, because we will now have to import more of our oil.
It isn't just the jobs from the oil and gas sector that will be lost - what about the renewable energy sector? The renewable energy sector is one of the fastest growing sectors in the economy; in fact the solar energy sector is growing at a rate that is ten times faster than the average growth rate. Will this trend continue if low oil prices persist? California has 15,397 projects planned, Texas has 6,368 projects planned, and Hawaii has 5,748 projects planned (cited here). What will happen to those projects if oil prices remain low? These projects will not come to fruition.
As stated above, it isn't just energy related jobs that will be lost, other sectors will hurt as well. Over the past 4 years, America has been enjoying a small manufacturing renaissance, and this was made possible because of cheap natural gas. Cheap natural gas brought down the costs of American made products by decreasing the electricity rates for American factories, thus making American manufacturing more competitive on the international stage. The strange thing about the cheap natural gas America has produced, is that natural gas rigs have decreased drastically, while production has increased substantially.
These two charts below are from Baker Hughes and the Energy Information Agency (EIA). The first shows the gas production from certain regions in America. The second shows the rig counts coinciding with the gas price.
There is a correlation in the decrease of gas rigs, a decrease in natural gas prices, and an increase in overall natural gas production. So, the question that remains is what made this possible. This chart below might explain why.
Despite the significant decrease in natural gas rigs, production of natural gas still increased, because natural gas is being produced as a byproduct of shale oil production. The increase in oil prices enabled natural gas production to increase despite the decrease in natural gas rigs, because the higher oil price made natural gas production as a byproduct economic - thus enabling the US to produce an enormous amount of cheap natural gas. If low oil prices persist, natural gas production will drastically decrease over the next 9-18 months, because these wells will no longer be economic to produce in a low oil price environment. This will put the American manufacturing renaissance in danger, and because the US will no longer have cheap natural gas, the cost of manufacturing in the US will rise again. Now the US might be able to replicate its natural gas production volume in 2-3 years from now even if low oil prices persist, but it would require much higher natural gas prices, so people are incentivized to start producing natural gas from rigs that have been previously abandoned.
The effect these oil prices will have on the economy is fearful enough, but what the mainstream press also fails to understand is the effect it will have on the financial markets. Since early 2010, domestic oil and gas producers have raised 550 billion dollars of new bonds, due to the Fed's zero interest rate policy (ZIRP). When shale oil and gas companies issued these bonds, shale oil and gas companies issued these bonds with the idea that oil prices would be around 80 to 100 dollars a barrel. Now that oil prices are much lower, there is a good chance these companies may not be able to pay the bondholders back. But even at those prices, shale oil wells aren't highly profitable wells. In fact here is what one insider said about shale oil and gas companies profitability, "Come January we'll be free cash flow positive, which is a rarity in this business," Greg Smith, Vice President of XXI's Investor Relations Department. When an industry as a whole has a hard time generating free cash flow, this makes growth at a sustainable rate almost impossible, especially when the price of what they sell has declined drastically. A default of junk bonds from shale oil companies could cause a great spike in interest rates, and could potentially spill over into the general bond market, the equity market, and the housing market as well. A single crisis spilling over into the rest of the economy is what happened during the subprime housing crisis, which ultimately made its way into the overall housing market, equity market, and general economy.
In conclusion, I wanted to set forth the immediate problems that would surface in the economy, if oil prices remain this low for an extended period of time. A lot of economic growth over the past 3-4 years has been due to the shale oil boom, and now you can see why low oil prices for an extended period of time will derail that growth. I am not claiming that there are no benefits to low oil prices anymore, in fact I believe over the long term, cheap energy is always beneficial to the economy. However, I believe that if the Fed decided to let this bubble pop, there will be pain, and the press should acknowledge that sub 60 dollar oil means a lot of jobs will be lost and could possibly drive the US back into recession.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.