WASHINGTON – Oil prices keep going down, and down. We are now around $ 50 a barrel, or even lower. On balance, this should be good news for America, still a major net energy importer. Yes, we know that the US has made news by increasing its domestic oil production by 4 million barrels a day in just a few years, an astonishing accomplishment. Right now, US energy companies have to face this headwind of low prices that cut into their current and projected profits. Many of them will not make it. But the rest of the US economy will benefit.
Energy sector will suffer
Let’s put these recent developments in context. Clearly low crude prices are hurting the large and now expanded US energy sector, from energy companies to the vast universe of oil services companies and various manufacturers that produce the equipment necessary for oil exploration, drilling, transportation, storage, distribution, and what not.
It is also clear that the industry outlook has changed, dramatically so. The US shale oil sector looked very attractive with oil at $ 100 or $ 90 a barrel. However, If we are forecasting oil at $ 50 for the indefinite future, all of a sudden this business looks pretty awful.
In fact, we can safely predict that many smaller and financially weaker US energy companies will go out of business pretty soon, because their production costs are too high. Expect bankruptcies and consolidation in the US energy sector, while investors may as well forget about high profits. Energy stocks are way down, and there is no hope for a speedy recovery.
Oil producing states to be hit hard
Obviously this oil sector recession will hit hard the states that benefited the most from the recent energy boom. Think of North Dakota or Texas. Expect cascading negative effects, from collapsing real estate prices to empty shopping malls, or restaurants closing down in oil boom cities.
That said, while parts of America will suffer, and the US energy sector and all its suppliers and vendors will have to retrench, substantially lower oil prices is unequivocally good news for the broader US economy.
America as a whole will benefit
Notwithstanding the incredible domestic production surge, America still imports about 50% of the oil it consumes. Lower oil prices benefit our balance of trade. Billions of dollars stay at home. Besides, today the average American is paying a lot less for gasoline, and this relief at the pump translates into the equivalent of a tax cut, or a wage increase.
When will this end?
That said, how long is this low oil prices season going to last? This is very difficult to say. Energy markets do not behave like other markets. Right now it seems that Saudi Arabia –the world’s largest exporter– has no intention to cut production, because it is focused on retaining market share. Therefore the Kingdom is willing to sacrifice profits in order to keep all its customers.
Saudi Arabia controls this game
The question is for how long? Well, here the topic shifts from economics to politics. Saudi Arabia can still make money selling oil even with prices at or below $ 50 a barrel. But the country’s budget is based on a much higher oil revenue. The Saudi Government has already announced that it will run a budget deficit on account of lower oil revenue.
In the near term, this is not a problem. Saudi Arabia has a very large financial cushion, estimated at around $ 750 billion dollars. Therefore it can afford to endure the pain of lower oil prices for quite a long time –years not months. But not for ever.
So, the question is for how long? Are the Saudis willing to deplete their cash reserves in the hope of seeing their financially weaker competitors go belly up much sooner? It is clear that unless there is going to be a massive demand increase, oil prices will recover only when supply will be cut. If no one is willing to turn the taps off, then we shall have to wait for the weakest producers to be driven out of business.
Will the US shale oil sector survive?
Back to America, this totally new situation is clearly a major hurdle for the relatively young shale oil sector. This low prices “stress test” will show if shale oil is truly viable, or if it was just a niche market made possible by very high oil prices.
We have to see if the US energy companies have the ability to lower their costs and stay in business, even when faced with dramatically lower profits.