In response to a dramatic increase in U.S. oil production over the last several years, the Organization of Petroleum Exporting Countries (OPEC) decided in November 2014 to dump low-cost oil into the global markets in an effort to drive down the price of oil and punish U.S. oil producers. As a result, crude oil prices have fallen by about 50% over the last year.
So, are much lower oil prices good news for the U.S. economy? I think most people would rather pay $2 for a gallon of gas than $4. But in order to fill up your vehicle you have got to have an income first. Since the last recession, the oil and gas sector has been the number one creator of good jobs in the U.S. economy by far. The American oil and natural gas industry adds $300 billion - $400 billion annually to the U.S. economy – without which the U.S. GDP would be negative and the American economy would still be in a recession. Barack Obama loves to stand up and take credit for the fact that the employment picture in this country has been improving slightly. But without the growth in the oil and natural gas industry over the last decade, unemployment would be through the roof.
To understand this better, let’s look at capital expenditures (capex). Investopedia defines “capital expenditure” as:
“Funds used by a company to acquire or upgrade physical assets such as property, industrial buildings or equipment. This type of outlay is made by companies to maintain or increase the scope of their operations. These expenditures can include everything from repairing a roof to building a brand new factory.”
Needless to say, this kind of spending is very good for an economy. It builds infrastructure, it creates jobs, and it is an investment in the future.
In recent years, oil and gas companies have been pouring massive amounts of money into capital expenditures (capex). In fact, the oil and gas sector is responsible for 1/3 of S&P 500 capex. Companies make the investments because they believe they will get a good return on those investments. Unfortunately, when the price of oil crashes those investments become unprofitable and capex gets cut. Many companies in Kansas and elsewhere began cutting capex by 40%-50% early this year, but now we are seeing companies making 75%-80% cuts in capex.
The Kansas Corporation Commission (KCC) will issue about 2,500 drilling permits in 2015 when it issued 7,100 permits in 2014. We are seeing significant drops in drilling rig counts (Kansas rig count in October 2015 is 40 when it was 123 in October 2014). Companies are deferring well completions and many high-cost marginal wells are being temporarily shut-in. This is having a profound impact on the oil and gas service sector where we are seeing large job cuts ~ 131,000 direct industry layoffs and about 450,000 indirect industry layoffs and $63 billion in capex reductions nationwide.
In Kansas, much like the rest of the nation, some oil and gas service companies have laid off as much as 30% of their workforce and/or reduced wages by as much as 20%-25%. The oil and gas industry agonizes over losing their workforce. They will do everything they can to reduce costs to keep from laying people off. Tough choices have to be made. The U.S. oil and natural gas industry generates an economic stimulus of almost $1.2 trillion in gross product each year as well as supports more than 9.3 million permanent jobs nationwide.
The ripple effects are everywhere. If you think about the role of oil in your life, it is not only the primary source of many of our fuels, but is also critical to our lubricants, chemicals, synthetic fibers, pharmaceutical, plastics, and many other items. The industry also supports almost 1.3 million jobs in manufacturing alone. If you think about the law, accounting, and engineering firms that serve the industry, the pipe, drilling equipment, and other manufactured goods that it requires, and the large payrolls and their effects on consumer spending, you will begin to get a picture of the enormity of the oil and gas industry. And these are good paying jobs that comfortably support middle class families. These are precisely the kinds of jobs that we cannot afford to lose.
In recent years, there has been a noticeable economic difference between areas of the country where oil and gas are being produced and where they are not being produced. Since December 2007, a total of 1.36 million jobs have been gained in oil producing states. Meanwhile, a total of 424,000 jobs have been lost in non-oil producing states. Clearly, lower oil prices do not compensate for the loss of capex in the U.S. economy.
If oil prices start going back up, much of the negative impact of lower oil prices can be averted. The longer oil prices remain low, the more likely that the oil and gas industry will continue to constrict. In turn, considering the economic impact of the oil and gas industry, that would be detrimental for the economy as a whole.
While we may enjoy lower gasoline prices resulting from low oil prices, lower gasoline prices do not compensate for the collapsing capital expenditures and rising unemployment in the U.S. economy.