Wednesday, January 28, 2015

Oil Prices Dropped - Now What? 


Recently, over food and coffee I had the pleasure of sitting down with some businessmen from overseas.  As you can guess the big topic of discussion was the sharp decline in the price of oil.  For those of you who may not be following the topic closely – oil prices have drastically declined over the past 3 months causing much speculation and concern.  So much so, that there are some who are scared that the US will again enter into a recession.   Of course, I can understand that, as the price of oil has plunged by more than half since June 2014, reaching levels last seen during the depths of the 2009 recession.  
With everyone seemingly on the edge of panic mode, I had to ask myself, will this really lead to a recession?  What does this mean for manufacturing?  Is it possible that the lower oil prices can actually increase business?
Well to answer that question, I did a little research and took a look back to see who suffered as a result of rising oil prices.  It turns out, there were three major areas domestically affected when the prices rose up around the $100 barrel mark.  
The first area was Consumer spending.  I know - this one is obvious.  Consumers as a whole backed off from unleashing the full potential of their annual budgets.  They were generally conservative due to the rising costs of transportation, food, and energy costs they incurred to run their businesses and households. The consumer would back off on driving.  Car production suffered.  The consumer backed off on shopping.  Stores backed off on expansion and building.  Consumers back off on travel.  The airline industry backed off on fleet expansion and operated conservatively. Essentially, It was one big fat domino effect.  Everyone was raising rates and costs, thus it all affected the general consumer. 
The second area was the Unemployment rate. I was surprised to learn that just a $20 increase in the cost of a barrel of oil cuts 0.4 percentage points off growth in gross domestic product and increases unemployment by 0.1 percent, according to a study, by the Energy Information Administration, part of the federal Energy Department.  You see, when a business has to adjust their budgets for higher energy costs and lower consumer demand the result is they lay people off.  Businesses just have less money to give to employees in wages.
And the third area was the Manufacturing sector.  In just about every area of the Manufacturing sector the cost to do business increased as transportation and energy costs rose.   The businesses absorbed the cost increases, which in some cases led them to make the choice of higher end-item prices to offset the increase, which subsequently led to decreased demand for their products. Essentially, they had to rob Peter to pay Paul.  
Now that we have briefly looked at what happened when the oil prices skyrocketed, let’s look at what should happen to these three areas now that the oil prices have tanked.  

In June of 2014, when oil cost $107 a barrel, U.S. employers added a healthy number of jobs – 267,000. Now, with oil below $50, hopes are rising that hiring in the United States is poised to intensify.  Goldman Sachs forecasts that if oil stays near its current price, the economy will add 300,000 more jobs this year than if the price had remained at its June level.  From gas-station prices to utility bills, consumers and businesses are now enjoying savings on basic energy costs. It means more people can splurge on purchases from clothing and appliances to vacations and dinners out. That stronger demand will likely require some businesses to step up hiring, which would circulate more money through the economy and perhaps fuel further job growth.

Due to lower oil prices, it is predicted that the Consumer will have a net gain increase by $920 per year for each household. The average propensity to consume is around 90 percent, so the average US household could spend around an additional $825 per year.  According to Bloomberg Businessweek, “Several districts “expect somewhat faster growth over the coming months,” the Fed report showed. “Payrolls in a variety of sectors expanded moderately” while “significant wage pressures were largely limited to workers with specialized technical skills.”
So if it’s true that Consumer spending and employment is looking strong than can't we expect the Manufacturing sector to fair well during the decline in oil prices.  I would even dare to say, the manufacturing sector might actually thrive.  If Consumer’s spend, businesses hire.  If Consumer’s travel, auto manufacturing increases and so does the airline industry.  In fact, Bloomberg Businessweek just reported that the production facilities of Boeing Co. (BA:US), the largest U.S. exporter, cited “strong” commercial aircraft production and “sizable” order backlogs.  If Consumer’s spend, then theoretically shouldn't the aerospace, automotive, marine & naval and the welding industry follow suit?   

Personally, I think the manufacturing sector is at a pivotal moment.  The "powers that be" can operate conservatively OR better yet...they can be forerunners, leading the way for growth and opportunity in the US.  It seems that all the signs point to growth and stability.  But nonetheless, I'd love to hear from my readers as each of you have a unique perspective on how it will or will not affect you.  It will be interesting to see how 2015 pans out and I'm sure this won't be my only post about the topic.  

PS:  It's great to be back at Atlas Bronze & in the bronze business again!