The Upside and Downside to Low Oil Prices

Bob Johnson: It's great to be here today.

Glaser: So, it seems like oil has not found its floor yet. Just when you think it couldn't go lower and people say it's not going to hit this level, it hits that level. Let's talk a little bit about what kind of impact this will have on growth in 2015 and beyond. Can you start by just giving us a sense of the scale of how important energy and how important gasoline prices are to consumers and to the U.S. economy?

Johnson: Gasoline represents about 2.3% of consumption overall. And when you throw all of the energy, the utilities, and so forth in there, it's about 4.3% of the economy. So, it's an important part--especially when prices are swinging wildly--but not overwhelming to the data.

Glaser: So, it certainly seems, just at first glance, that you have lower oil prices, and so that's more money in consumers' pockets; they are going to go out and spend it. Maybe this is a big net positive for the economy. Is that too simplistic of an analysis?

Johnson: I think it is--and I've been guilty of that in the past. I have gone through and said, "How much oil have we used, and then how do we multiply it by price?" And it puts billions and billions of dollars back into the consumer's pocket. But that misses a lot of different points, and there are all sorts of things that are offsets to the positives. And again, it's generally a positive thing; I'd take lower oil prices any day of the week. But it isn't a one-way street.

Glaser: So, let's look at some of those positives. Have we seen any signs that consumers are spending more due to these lower prices?

Johnson: Well, it gets confusing because it depends on exactly what period you look at. But really since July, when prices started to come down, consumption has generally picked up, which is good news, and oil prices have clearly been part of that. On the other hand, as the price of oil has fallen even further in the last couple months of the year, we've clearly seen the retail-sales reports not look as strong. People were kind of like, "Where's the money?" And frankly, some of it has already been spent. People did better earlier in the year--at about midyear. And now at the end of the year, it certainly didn't show up in this week's retail-sales report, which showed a pretty drastic decline, even when you strip out all of the oil stuff.

Glaser: What impact is it having on other parts of the economy like housing? Is there more demand for housing maybe further out, if people feel like gas is going to be cheaper for a while?

Johnson: There are a lot of longer-term dynamics--this idea of putting more money in consumers' pockets. But that can go away pretty quickly, especially if oil prices go back up again, even just a little. On the other hand, some of the longer-term decisions that people make--economic decisions based on lower-priced oil--really could change the game. And the question is whether it is going to be a long-term or a short-term shift. We've talked so many times in these videos about the exurbs dying and people wanting to live in the city--the young people because of the social life and old people because they don't want the maintenance and they want to be closer to activities and near their families. And with high gasoline prices, you really don't want to live in the exurbs.

Well, [do lower gasoline prices, then,] tip the equation a little bit more back in favor of homes out in the exurbs, which is where you are tending to build new homes rather than remodel something that's already there? So, if [gasoline prices] stay low for a while, yes, it could be a big help to housing; but who knows if we're really going to stay here for long?

Glaser: Let's look at some of the negative issues that will come from lower oil prices, though. Do you see that this is going to be a big drag on the economies of big energy-producing states like Texas or North Dakota?

Johnson: Absolutely. I don't think North Dakota is going to make any big difference to the data. I think they could fall pretty fast, and it really wouldn't make a huge difference to the U.S. numbers overall. But Texas is a big deal. It's one of the very biggest states in the union, and it's clearly a state that's done very well in this recovery. Some of the housing numbers, some of these retail sales numbers that we've seen, if you pulled them apart, some of it is because of Texas. And now, if Texas is working in reverse--I've seen this movie before in 1986, in 1998 when oil prices collapsed and their economies collapsed and their banks collapsed--I think that there is certainly a case to be made that some of the shortfalls in Texas will offset some of the benefits that retailers in New York or Illinois might get.

Glaser: How about at the corporate level as we are approaching earnings season? Do you have a sense of what impact these prices are going to have on earnings--particularly energy companies?

Johnson: It's supposed to be huge. Just a few months ago, everybody was thinking fourth-quarter growth would be about 6% to 8%, year over year--fourth quarter to fourth quarter. Now, they're thinking 1%. That isn't because the economy has slowed dramatically--if anything, we've talked about a little bit faster growth in the economy. It's because of oil prices. It's really pulled down the S&P earnings-growth rate. Energy stocks are not an insignificant part of the S&P 500--say, 10% to 15%.

So obviously, those are down fairly significantly, and their earnings are down fairly significantly. It's having an impact there. And certainly, that has a carry-on effect because the market starts acting more poorly. That's certainly not a good thing for the high-end consumer who's been driving this recovery. We've looked at gains of over 30% one year, well over 10% another year. And now, if we're suddenly looking at it moving in reverse, maybe that slows some of the spending there. And that's one of the unintended consequences that maybe people aren't thinking about of a weaker energy price.

Glaser: So, when it comes to earnings, though, the declines in the energy stocks will not be outweighed by increases in other consumer spending?

Johnson: Absolutely. And part of that is because the energy sector has such high fixed costs, and it hits right away. That's why we're seeing such a dramatic decline in the S&P earnings expectations for the fourth quarter--because the energy earnings are falling so much faster than retailers, who tend to have thin margins, are improving.

Glaser: So, you mentioned earlier that one of the big questions is whether there will be sustained lower oil prices or [whether this is] just kind of a blip. What are your expectations there? Is this just going to be something we're not even talking about a year from now, or is this really the start of a big shift?

Johnson: Well, I've generally been of the view that oil prices, because supply and demand are relatively close to each other--we're within one million barrels a day on a 93 million barrel a day basis--that they can't stay low forever. But on the other hand, the oil shale came along, we had all this new production, and prices didn't go down either. So, my view right now is that we probably can't stay down this low forever--that we certainly have to have higher prices if we're in the high $40s right now. We certainly probably belong somewhere up in the $70s and $80s longer term--but probably not all the way back to the $100 level, which had so many geopolitical issues and trading issues involved in it. I probably don't think we're going to get all the way back to that $100 a barrel price in the next couple of years--maybe longer term, yes.

Glaser: Bob, I certainly appreciate your thoughts on oil today.

Johnson: Thank you.

Glaser: For Morningstar, I'm Jeremy Glaser. Thanks for watching.