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Market News

 December 04, 2014
Low oil prices are a good thing, right? Not always.

 Plummeting oil prices seem like good news for US consumers, who are paying less at the pump than they have in four years. But cheap crude has its drawbacks -- from undermining domestic oil production, to discouraging investment in new energy sources.

US consumers are reveling in low oil prices. Inexpensive crude translates into savings at the pump, leaving Americans with more money to spend on groceries, clothing, and holiday gifts. That, on the whole, should give the US economy a lift.

But there are serious potential downsides to slipping prices, too. If prices continue their descent, states with shale oil booms could start hurting. Banks and pension funds that invest in energy are also vulnerable to the impacts of tumbling oil prices, and the US economy could be harmed by low inflation. Globally, efforts to decrease greenhouse gas emissions could face headwinds as drivers take advantage of the cheap fossil fuel.

"A large part of the US economy is invested in oil and gas production," says Morgan Downey, a New York-based commodities trader, adding that the fall in oil prices "definitely has a negative impact on investors and pension plans."

Oil prices have tumbled nearly 40 percent since June. Growing US production and the return of crude supplies from Libya and Iraq created a surplus of oil in the global market over the summer. But with soft demand from Asia and Europe, that extra oil was left sloshing in the marketplace, driving down prices. Prices fell further last week after the Organization of Petroleum Exporting Countries (OPEC) -- the cartel of major oil-producing countries like Saudi Arabia and Venezuela -- decided to let oil prices fall by maintaining their production at current levels.

On the whole, it's a win for the US economy since US oil demand goes beyond the dramatic amounts of new oil flowing from North Dakota and Texas.

"Despite the impressive recent gains in natural gas and crude oil production, the U.S. still is a net importer of energy," William C. Dudley, president of the Federal Reserve Bank of New York, said Monday at Bernard Baruch College. "As a result, falling energy prices are beneficial for our economy and should be a strong spur to consumer spending."

But what happens if prices dip too far, too quickly? At some point, producers earn less than what it costs to drill US shale oil out of the ground. Things could then get dicey, particularly in states whose job growth and economic vitality stem from the shale boom.

"These falling oil prices are certainly going to affect the economies of North Dakota, Texas, and Alaska," says Andrew Lipow, president of Lipow Oil Associates in Houston, in a telephone interview. "Especially North Dakota and Texas, where the shale boom is."

The break-even price for oil produced in North Dakota and Texas shale formations is relatively high, and Mr. Lipow says oil prices in the $60 to $70 a barrel range would impact production levels in North Dakota and Texas. West Texas Intermediate, the North American benchmark for crude oil, hovered around $67 a barrel Wednesday.

And there are signs that producers are already starting to scale back. There was a 40 percent drop in the number of new well permits the US issued in November, Reuters reports -- a sign that low prices have made producers nervous about the future.

"That's a huge drop off, and it's all in the Bakken in North Dakota, and the Eagle Ford and Permian in Texas," Mr. Downey says in a telephone interview Wednesday. "Usually that's the first leading indicator to show this may be the floor for oil prices. You're getting a supply side response."

Low inflation is another concern as oil prices fall. Inflation is already below the Federal Reserve's 2 percent target, making it hard for the central bank to raise interest rates to pre-recession levels.

Regional banks stand to lose the most of any US banks if shale producers cut back in a low-price environment, as the Wall Street Journal noted Monday. Energy loans comprise between 10 and 20 percent of several regional banks' portfolios, and if oil prices decline further demand for those loans could dry up.

And low prices could impact the environment as well. Low oil prices encourage the use of the fossil fuel, which contains climate-warming carbon. At the same time, cheap oil makes investment in cleaner alternative fuels less attractive.

Cheap gas also means US motorists may drive more. Just last month, low gas prices encouraged more Americans to buy automobiles in November than in any November since 2003. More cars burning more fuel could ramp up greenhouse emissions, just as the Obama administration tries to cut carbon from major emitters like coal plants