This graph shows a decline - albeit not as significant as for gasoline.
It is true that the fall of oil prices only affect investors, just like the fall in real estate prices in 2008 only affected investors. The problem is that a lot of money that is (was) lent to the oil industry (real estate) is (was) backed by the worth of the oil (real estate). When the prices drop, the security of these loans is undermined, causing a reduction in money available for new loans. This is what hurts the overall economy.
But, the overall premise that lower fuel prices are good for the economy is true, once the economy gets over the problem with the loans. The guy who is now filling his car for $33 when six years ago he was paying something like $60 for the same tankfull is going to see a increase in his spending money.
Frankly, I don’t expect these low prices to last long; at most a year or two. That is based on the fact that a lot of contracts for fuel supply are being wrtten now based on the current prices and a cut in supply (by the major oil companies) now would only reduce the amount of money they make. They will reduce production over the long term, however, which will raise the prices and, generally, the economy won’t mind as long as the price does not go much over what it had been for the past year or so (about $80-$100/bbl). The folks in Houston are going to have a rough go of it in the meantime.
DING DING DING
As a professional trader I agree 100% with that article. Discerning the casual relationship between something like oil prices and the equity prices in the short term is nearly impossible, IMO. There are simply too many variables. It is possible that the data scientists at Renaissance Technologies have a model that has some predictive value, but I assure you it has more inputs than oil price and direction.
Next time you hear someone matter-of-factly state that oil prices are good/bad for stock prices ask them to explain their views vis-a-vis the crack spread and the yield curve. I’d bet they change the subject pretty quickly.
Damn, that sounds eerily familiar…
It’s nice to have professionals back me up, though. 
It’d be nice if people started to realize that the financial media is as worthless as the regular media. Their primary interest is filling airtime/creating content.
I’m not an economist, but these are my thoughts from a lay perspective:
[ol]
[li]The absolute price of oil is neutral to the world economy; it’s a big determinant of which people have more or less money but does not add or subtract to the overall wealth of the economy. When considering the economy of an individual country (or regions within a country), then it depends on whether that country/region is a net importer or exporter, and to what extent.[/li][li]Independent of the above, sudden and significant movements in price either up or down upset equilibrium in that they can cause investment losses which can have a ripple effect, which will frequently be negative.[/li][/ol]
For a country or region which has a significant energy export/import imbalance, the effects of 1) can overwhelm the effects of 2), whether to the positive or negative.
A lot of the problems with the end of the bubble came from the drying up of home equity loans, which were financing a lot of consumption, and the feeling of many people that they were poorer due to lower equity. Then they actually became poorer when the consumption drop led to layoffs. So it’s not true that the housing price drop only affected investors. Though it certainly affected them a lot.
Producers are driving supply, not oil companies. There was an article this weekend about how gas stations benefit from price decreases. Part of it is that they can lower prices more slowly than their costs fall. I believe I read that refineries do well also, since they have a fixed cost per gallon processed which is independent of the price. So only a part of the oil industry gets hurt. A big part, true.
Do you have a cite for the exposure of banks due to loans backed by oil? I can’t imagine it is close to the mortgage market.
What I’ve read is that the drop in the market is due in part to the fear that dropping oil prices are signals that the global economy is weaker than expected. I don’t know how that could be modeled.
Let’s all have warm, happy feelings that Iran and Russia are suffering.
One thing that’s worth bearing in mind is that many people believe that this particular price drop is being deliberately engineered by Saudi Arabia for the express purpose of driving many US and other Western oil drillers out of business. The idea is that the latter face higher costs of production, and their breakeven point is much higher. If prices stay low for a long enough time, a lot of that production would be shut down, which would give the SAs a firmer grip on the market and the ability to raise prices back up to where they were, or even higher.
In theory, the US producers could then start up production again, and it would undoubtedly happen to a large extent, but investors would be leery of investing in businesses that could be shut down and possibly driven into BK by the actions of OPEC, and it would have a dampening effect on production, overall.
Bottom line is that to the extent that this is true - or even if it’s not the Saudi intention but just an outcome of their actions - any gain for the US economy could be temporary, while there would be longer term harm to the US energy sector and US prospects for energy independence.
Number 1 is incorrect. Oil is an input and not a consumption good. Thus a lower price of oil means more goods for the same amount of input. This is good for the global economy. As you point out large changes in input prices can upset equilibrium and cause negative effects until a new equilibrium is reached. Cetus paribus the new equilibrium will be a better world economy than the old equilibrium.
I’m not sure you’re completely correct about this claim, as oil would be both an input for production as well as a consumption good. But more importantly, I don’t see why this makes a difference to my point.
If you need more work - or more resources, e.g. oil - to produce the same amount of goods, then goods are being produced less efficiently, and this is bad for the world economy. But in this case, you need the same amount of oil as ever, and the same amount of effort to retrieve the oil. The only thing that’s changing is the price, which is changing due to other factors. So the goods are being produced using the same amount of human and capital resources, and the only difference is how much of the value of the final goods goes to owners of oil resources versus others. This is just an allocation issue, and is a zero sum game in terms of the world economy.
Although we like to think it isn’t so true anymore, the US economy is still intimately entwined with the fortunes of the oil industry. Much as it was with automobile production for so many years. A shudder in the oil market produces ripples in the economy almost instantly after a price adjustment. But it doesn’t affect all sectors of the economy equally.
There has been an increasing uptick in domestic oil production since the technology involved in extracting oil from shale has gotten better. While it is quite true that the US had exhausted a fair amount of our domestic oil supply available to us through traditional extraction methods, this new and improved technology has opened the vast reserves in the Bakken (No Dakota and surrounding). Opening the Bakken substrate to extraction is a 21st century version of a gold rush. The reserves there are potentially greater than those in the Middle Eastern countries. We’ve also seen a resurgence of oil production in Texas’ Permian fields thanks to shale extraction techniques. When the ‘easy oil’ was exhausted, many of these fields were virtually abandoned, but now they are booming again. There is a very real possibility, even a probability, that the US will become a net oil exporter by the end of the first quarter of the 21st century.
Many of the effects of this new and renewed supply of domestic oil have yet to be felt. It was high foreign oil prices and shortage of domestic supply that spurred the expensive research that led to the development of shale extraction techniques. Without that impetus to research, businesses supporting such research will falter. Oil companies themselves will see a two-sided effect - reduction of the costs of R&D and a reduction in profits at the lower prices. I don’t worry for the oil companies. They will make up those profits in volume sold.
Green industries, their employees and suppliers, may suffer, at least for a time, from the availability of reasonably prices domestically produced oil. The economy tends to follow its pocketbook, not its conscience, when it comes to fossil fuels.
All it takes is one visit to Williston, ND, to grab an example, to demonstrate both the costs and the benefits of an oil boom. Again, similar to the gold rush, necessary supplies like housing, food, etc. are scarce and their prices are inflated. Inversely, these areas are at full employment at very high wages. Tax bases in these areas are skyrocketing and the benefits involved are many.
The airline industry has stated it will NOT lower prices based on reduced oil prices, even though they can. Because people are still flying in record numbers in spite of the inconvenience and cost of doing so, they have no incentive to cut back. Perhaps as people begin to drive more as a result of reduced fuel costs, they may have to rethink their position. I for one, hope that is the case, being a frequent business traveler.
Other industries may pass the savings along to the customer, while some may clutch on to the increased fees of recent years just like the airlines are doing.
Investors will be uneasy, that’s to be expected. They have a low change tolerance anyway, particularly when it comes to their favorite investment vehicles, like oil stocks.
Ultimately, though, and on balance, I think a decrease in oil prices due to increased domestic production is the high tide that raises all boats for the US. In the '60s, the saying was ‘what’s good for GM is good for the country’. In this new century, it may well be what’s good for Conoco/Exxon, etc, is good for the country.
There are scenarios where a price drop could be a sign of bad things for the economy but keeping all things equal it should be a good sign. If oil is a input for widgets then cheaper oil means you can produce more widgets for the same price or the same amount of widgets and have money left over to make something else. Either way the world economy grows.
That doesn’t address my point.
The guy who makes the widgets will have more money left over to make something else, but the guy who sells the oil will have that same amount less money left over to make something else. So net-net the impact is neutral.
As noted above, what you write is true if the are changes in productivity. Not if it’s just changes in price.
That assumes that the money will be used in the same way in both cases. That’s usually not true. As your link mentioned, the Saudis stashed their oil profits in the past few years someplace (T-bills?) which probably leads to less global economic growth. On the other hand if Iran subsidized their economy with oil profits, in that case oil price declines might decrease global economic growth. So it depends.