STONY BROOK, NEW YORK – The collapse in the price of oil is a huge source of anxiety for many financial market participants. I suppose that’s understandable.
Investors have been very excited for the past several years about the promise of tight oil, which is extracted by hydraulic fracturing, or fracking, of rock formations where oil is present. This was a powerful, simple story that asset managers and the financial media could understand, since oil is something that almost everyone uses. The fracking boom lured trillions of dollars in investment, and domestic oil output soared, pushing the United States close to energy independence and lowering demand for imports from big crude producers.
With the recent dive in oil prices, that all seems like ancient history now.
The price plunge will wipe out many small companies involved in fracking, as well as plenty of others in oil services. It will cause many high-yield bonds to go into default. It will generate big losses at major energy companies, and will lead to job losses throughout the industry. In the short term, a negative shock to the world economy and the financial markets will probably be the main effect of the oil collapse.
But only in the short term. Most U.S. industries are consumers of oil and other fossil fuels, not producers. The U.S. is less of a net energy importer than it used to be, but it still consumes more fossil fuel than it produces. The fall in oil prices means that trucking companies are going to be able to buy less expensive gasoline for their fleets. Construction companies will be able to build office towers and houses more cheaply. Farmers will spend less to plant and harvest their crops. Intel won’t have to pay as much to run its microchip plants, nor Boeing to run its aircraft factories.
It will take time for investment to shift to all the industries that will benefit from lower energy prices — but not too much time. The initial shock from the oil collapse might be negative, but it will be outweighed by the positive effects before too long. In other words, most Americans should be celebrating the oil drop, not lamenting it.
The real danger isn’t the decline in oil prices, but the thing that caused most of the decline in the first place: China. The dramatic slowing of China, which has become the workshop of the world, is behind much of oil’s latest fall. The slow unwinding of a property bubble, with its attendant debt crisis, will probably continue to exert a major drag on Chinese growth during the next few years.
That means a long slowdown in demand for oil. But more importantly, it also means a drop in global growth. China’s slump will ripple across much of the global economy — resource exporters in Latin America, Africa, Southeast Asia and the Middle East will all feel the pain. Countries that export industrial machinery to China, such as Germany and Japan, will also be hit, as will countries like South Korea and Taiwan whose economies are closely linked with China’s.
Although the U.S. and Europe export relatively little to China directly, the reduction in global growth will hurt their economies too. The slowdown in global trade isn’t a huge threat to the U.S. economy, but it’s a bigger threat than the oil price collapse.
In the long run, we want oil prices to fall, but for the right reasons. We want oil prices to go down as new technologies — solar power, battery storage, biofuels, hydrogen or whatever — make the practice of digging up and burning dead dinosaurs obsolete. Eventually we want oil to go the way of whale oil — once a critical energy source, now a historical curiosity.
Today, the tumble in the oil price is partly a result of negative developments in the global economy. But in the future, as electric cars and solar power advance, oil prices might fall for economically positive reasons. Let’s hope that someday new technologies will keep oil prices low forever.
Noah Smith is an assistant professor of finance at Stony Brook University and a freelance writer for a number of finance and business publications.
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