Here we are standing at the gas pump and smiling. At the local Texaco station I can get filled and washed for less than it cost to fill the tank only a year ago. Gas for the 1,260 mile round trip from Dallas to Santa Fe costs $20 less. It’s difficult to get any sense that the sinking price of oil is anything but good news.
It feels particularly good if you remember the winter of 1973. Living in Brookline, Massachusetts, I cut tree branches and watched every fallen branch disappear from a nearby park as we all scrambled to keep our houses heated during the embargo. In a matter of weeks the smooth comfort of everyday life disappeared, large cars could not be sold, every builders’ supply store was out of insulation, and lowered ceilings became popular. Working on a book published in 1975, The Household Economy, I calculated that the humble aluminum storm window provided a return on investment of 25 percent, more than IBM earned on shareholder equity.
Today, it’s hard to argue with money in your pocket. Lower oil prices put downward pressure on interest rates and air fares, just to name the obvious. But it also puts pressure on the price of all petroleum based products.
So close your eyes and imagine all those rows at Toy’sRUs, Target, WalMart, and Best Buy. What do you see? Plastic, miles and miles of petrochemical based plastic. Add some more savings for home heating and cooling bills, lower shipping costs for imports, and you start to get some impressive numbers. When you work the impact of low cost oil through the entire economy we’re talking about hundreds of dollars in savings per household— the equivalent of a very nice tax-free raise for millions of Americans.
So why worry?
Simple.
Oil is too cheap. You can get some idea of how cheap it is by taking a look at the exchange rate between oil and stock prices and how it has fluctuated since 1970. Measured against common stock prices, oil has lost 94 percent of its value since 1980.
More important, while consumer prices have risen 433 percent since 1970, oil prices have only risen only 351 percent. In other words, while energy prices appeared to be a source of inflation in the seventies and early eighties, they are now a moderating force. We can’t blame OPEC for inflation anymore.
Oil Is Cheap, Dirt Cheap
|
Year |
Average Oil Price | S&P 500 Index | Units of S&P500/ 1000 barrels of oil |
|
1970 |
3.18 |
92.15 |
34.5 |
|
1975 |
7.67 |
90.19 |
85.0 |
|
1980 |
21.59 |
135.76 |
159.0 |
|
1985 |
24.09 |
211.28 |
114.0 |
|
1990 |
20.03 |
330.22 |
60.7 |
|
1995 |
14.62 |
615.93 |
23.7 |
|
Dec-98 |
11.18 |
1149.00 |
9.7 |
Sources: James A. Gibbs, Bloomberg
How cheap is $11 a barrel? It costs more than $11 a barrel to get some oil out of the ground. If we have a sustained period of low prices— or an even greater glut and still lower prices— it will no longer be economic to lift the oil, collect it, and refine it. Wells that could be shut include a good deal of domestic production and much of the North Sea. Once shut down, wells can’t simply be turned on again. According to one recent report, nearly 50,000 domestic wells were shut down in the first six months of this year.
It’s difficult to imagine but oil, once a major source of government revenue, could become a source of government expense as it becomes necessary to either subsidize production or shut it down.
This will be a problem virtually everywhere in the world, with one notable exception.
The Middle East.
In addition to accounting for as much as 80 percent of global reserves, the Middle Eastern nations have the lowest cost wells in the entire world. Shutting down non-Middle Eastern oil sources will mean that the middle east, arguably the least stable part of the world, once again accounts for a rising share of global oil exports.
That would put Saudi Arabia, Iran, Iraq, and Kuwait in the cat bird seat once again, creating the circumstances for another surge in oil prices.
Bottom line: If you believe in “buy low, sell high”, oil is the biggest bargain in the world.
Photo: Andrea Piacquadio
(c) Scott Burns, 2022