Should You Really be Cheering about Low Oil Prices?
I know it is very tempting to be VERY excited about low oil prices. Many of us don’t have the luxury of subways and mass transit, so we are forced to drive our cars (often very large) around town to run errands and pick up kids. Many of us are filling up and having a deja vou (1990s gas prices) moment. We are old enough to remember $0.89 gallon gas and yet it was not too long when the country was freaking about $4.00 gallon gas.
Should we all be rushing to celebrate?
Before I continue I will write a disclaimer: Christa and I both live in Houston, Texas (tied heavily to oil and gas) and our husbands work in oil (Brad) and gas (Dave).
I will try and be as objective as possible, but want to explain it from an overall ECONOMIC perspective.
Every single job is somehow tied to oil. Whether you like it or not, YOUR job is tied to oil.
How is this possible?
The multiplier effect.
When the economy is good and the price of oil is high, there are lots of jobs created. When people have jobs and money they are able to go out to eat more often (waitresses), get their hair colored (beauticians), go on vacations (flight attendants, amusement park workers), buy cars (automobile factory workers, car sales personnel), and buy houses (realtors, furniture sales, teachers- property tax).
When oil prices plummet companies like Apache, Schlumberger, and Halliburton start laying off thousands of people. All of these people have families.
Here are a few questions about the recent events related to oil.
Why are oil prices plummeting? (from http://www.economist.com/blogs/economist-explains/2014/12/economist-explains-4)
Four things are now affecting the picture.
1. Demand is low because of weak economic activity, increased efficiency, and a growing switch away from oil to other fuels.
2. Second, turmoil in Iraq and Libya—two big oil producers with nearly 4m barrels a day combined—has not affected their output. The market is more sanguine about geopolitical risk.
3. Thirdly, America has become the world’s largest oil producer. Though it does not export crude oil, it now imports much less, creating a lot of spare supply.
4. Finally, the Saudis and their Gulf allies have decided not to sacrifice their own market share to restore the price. They could curb production sharply, but the main benefits would go to countries they detest such as Iran and Russia. Saudi Arabia can tolerate lower oil prices quite easily. It has $900 billion in reserves. Its own oil costs very little (around $5-6 per barrel) to get out of the ground.
** Interestingly, after the Saudi King died, the stock market went up a little.
Will Americans benefit by being able to find cheap flights?
Unfortunately, it appears the answer is no. Many of the airlines are using this period with low fuel prices and continued high airline price tickets to improve their infrastructure (replace planes, remodel aircraft, etc).
Ok, back to the multiplier. The multiplier explains how much a change in spending will increase the total overall money supply in our economy. If I spend $100.00 at The Shack Burger Joint in Cypress (such a cool place) our economy will grow by more than $100.00.
Question: By how much more than $100.00?
Answer: It depends. The truth lies in what The Shack does with my $100.00. Do they save most of it, spend most of it, or both?
Ideally, if you are in a recession (economic downturn), you WANT people/companies to spend the FULL $100.00. Why? Because it will have a trickle down effect.
Example: The Shack wants to expand their business so they hire construction workers. They save $10.00 of my money and spend $90.00 on the construction.
The formula for the multiplier is 1/mps (marginal propensity to save).
In this case the multiplier is 10 (1/.1).
You then multiply the money spent (100.00) x the multiplier (10). My $100.00 purchase grew the economy by $1000.00! (Because the construction company spent some, and saved some and the companies they patronized spent some, saved some, and it goes on).
What would have happened if The Shack had decided to save most of it? Let’s say they didn’t want to expand and instead only spent $10.00 and saved the other $90.00.
1/mps- 1/.9= 1.11 (Multiplier).
1.11 x 100.00 = $111.00
There is a very big difference between $111.00 and $1000.00!
If you are the government and want to stimulate the economy, what will give you the biggest bang for your buck?
A. Decrease taxes
B. Increase unemployment benefits
C. Increase corporate tax cuts
D. Give tax rebate checks
E. Increase food stamps
The answer is not A-E because in all of these cases, money might be saved by people and or companies. This is called leakage. 100 % of the food stamps will be spent!
Leakage is the reason that when $500.00 tax rebates are given out, the rich generally don’t qualify. The government knows that upper income people will have a larger marginal propensity to save compared to a family that is struggling to make ends meet.
Another example was when the government wanted to stimulate the economy by encouraging people to buy houses. If you qualified you were given a large refund. The government knew these new homebuyers would probably take the $10,000 and buy refrigerators, furniture, etc. They wanted people to spend the money.
Why do you think every city wants to host large events like the Olympics, Super Bowl, and World Cup? The multiplier effect! All of these people will be spending money that will grow their city’s economy exponentially.
What is an ideal price for gasoline? Just like most things in life, you want a happy balance. You don’t want $0.89 a gallon gasoline and you don’t want $4.00 a gallon gasoline. If we start creeping back to $4.00 a gallon gasoline, you can always make yourself feel better by reminding yourself that Europe has been paying much higher prices for years.
So the next time you get excited about cheap gas, think about it. If you are still ok with it, that is ok…I don’t blame you!