The Price of Oil is Still a Tax on the US Economy, but it's improving....

Oil recently broke below $80 per barrel and it caused me to reflect on its continuing importance to the US economy even though there is so much brouhaha over the price of gold.  So much has changed and yet so little has changed since 1973 regarding oil.  The US remains heavily dependent on foreign oil and Americans have learned relatively little from the lessons of the 1970s.  Technological advances frequently require more energy – not less – even as individually powered devices become relatively more energy efficient than their predecessors.  Consumers and producers today typically use more products and services and energy use continues its slow but inexorable climb.  Although the US consumes somewhat less oil than it did a few years ago due to recent weakness in its economy, the country still consumes more petroleum than it did in the 1970s. 


And oil is by far and away the largest energy source for Americans.  So when the price of oil goes up, Americans across all industries feel a real and substantial pinch.  So what exactly is the point of the Consumer Price Index (CPI) less food and energy?  Who can survive without food and energy?  Yes, I know, this form of the CPI removes a lot of volatility, but energy has its footprint everywhere in a modern economy and has to be considered in any serious economic analysis or measure of inflation.  And the US is still heavily dependent upon oil as a source of energy.  When the price of oil goes up, it raises the costs to produce a vast array of goods and services in the US and, in effect, serves as a “tax” on the US economy on top of the federal and state taxes already imposed on oil and its derivatives including gasoline.

Since the depths of the collapse in stock market confidence in March 2009, the price of oil rose from the low $40s to the low $90s at thebeginning of this year.   Earlier in 2011, however, the price of west Texas intermediate surpassed $110 per barrel.  Recently, the price of oil per barrel has pulled back below $80.  Much of the price of oil is driven by classic economics of the underlying demand for its use versus the ability of the oil producers to supply oil to meet this demand.  But there is probably at least one additional factor in the price of this commodity that contributes to this painful oil tax on our economy we have to bear as Americans – i.e. the chance of crises, political unrest or wars in oil-producing countries or their neighboring countries that would materially disrupt the world’s oil supply.  This uncertainty adds a premium to the oil price that goes up or down depending on the perceived risks of the moment.  Recently, I believe this perceived risk and the view of future oil demand have come down and accordingly so have petroleum prices. 

Nevertheless, some types of bad news for oil are good news for much of the rest of the US economy.  The professional skinflints of America (better known as CFOs) are acutely aware of oil’s pernicious effects and are among the first to respond to the high costs of oil.  These CFOs are the vociferous critics of their suppliers who are trying to force price increases on them and are the first to come up with cost cutting measure of their own tomeet the challenges brought on by the oil tax on the US economy.  All too frequently and to the detriment of the overall economy, this has recently meant letting employees go. 

 

In corporate America, these CFOs will also be the first to notice now that oil prices are beginning to come down and ease the “oil tax burden” somewhat.  With any luck, these CFOs will inform their CEOs that they will soon have some flexibility to spend on projects near and dear to their CEO’s hearts.  If the US does not enter another recession, a sustained drop in the price of oil should enable them to invest and grow again.  If oil prices can hold in the $60 to $80 range for an extended period of time again, I believe the US will begin to build off its employment base (albeit slowly) and can create net new jobs – especially in industries such as construction, travel and transportation and agriculture/ag-bio where energy costs are high.  Watch the CFOs here.  And with oil in the $40 to $60 per barrel range, the US can witness real new job growth.  Below $40 per barrel and we are talking substantial job growth.  Unfortunately, prices below $40 per barrel would probably lead to long term problems once again.  There would probably be too little investment in future oil production and too little investment in alternative energy sources due to complacency and uncompetitive initial price points.  I guess that is too much of a good thing….

 

In sum, oil prices have an impact on the US economy that is almost the inverse of housing prices.  (See my previous blog on this topic.)  Higher housing prices and new construction can drive the economy out of its doldrums.  Conversely, lower oil prices put more money in consumers’ pockets and give corporate CFOs and CEOs the confidence to begin spending again as long as we don’t experience another banking crisis at the same time.  Such confidence can rescue the US economy as well.   With oil at over $80 per barrel, however, I think it is difficult to convince consumers to dig deep and spend while they are paying down debt or to get CEOs and CFOs to hire new people for growth instead of investing in energy efficient lighting and teleconferencing systems to avoid the high cost of travel.  It will be hard for the US economy to get going again until the price of oil falls.  When the price of oil falls and it holds, that is a positive sign for the future.