Oil prices are dropping, and that’s great for Americans.

Oil Prices Are Tanking—and That’s Fantastic News for Americans

Oil Prices Are Tanking—and That’s Fantastic News for Americans

A Closer Look at the New Energy Economy
Dec. 11 2015 12:45 PM

Oil Is Tanking, and That’s Great

The financial press says the plummet is a sign of peril. Wrong.

A customer prepares to pump gasoline.
A man prepares to pump gas into his car on March 3, 2015, in Mill Valley, California.

Photo by Justin Sullivan/Getty Images

Oil, selling at $36 per barrel on Friday morning, is swooning to levels not seen in years. And most of the coverage in the financial press has been negative: It’s a sign of deflation! It’s wreaking havoc in the junk bond market! Cheap oil is causing job loss and sharp declines in capital investment by energy companies. It’s causing corporate defaults to spike. It’s causing the stock market to plummet!

Here are some headlines you should see—but won’t: “Price of Key Industrial Input Falls Sharply,” or “Regressive Tax on Working Americans Slashed in Half.” The reality is that, on aggregate, the decline in the price of oil—which is persistent, pronounced, and pervasive—is very good news for America, for most Americans, and for the world at large.


For example, there’s no inflation. The producer price index, the measure of inflation that takes into account what it costs companies to make stuff, came out Friday morning. It’s down 1.1 percent in the past 12 months, driven in large part by the fact that the price of energy is off 19 percent since November 2014. That’s good for companies. It means they can increase or maintain their profit margins without asking customers to pay more.

For consumers the news is even better. Friday morning, the Census Bureau released November’s retail sales data. The headline figure was meh: up 0.2 percent in November from October, and up just 1.7 percent from November 2014. That’s not so great. But I’d argue the muted growth in retail isn’t because Americans aren’t buying the stuff they need and want. Rather, it can be ascribed to the fact that the cost of the stuff they need and want is staying flat or falling. To a degree, getting through the day costs a little less than it used to. Look at spending at gas stations. In November, Americans spent $34.5 billion—down $8.57 billion, or 20 percent, from $43 billion in November 2014. Through the first 11 months of 2015, Americans have spent $401 billion at gas stations—down 19.9 percent from the first 11 months of 2014. Add it up, and the lower cost of gasoline is effectively putting $100 billion a year extra into the pockets of American consumers.

But here’s the thing. Rather than compensate by buying more stuff they don’t really need—another sectional, 10 more hoodies—Americans are putting the cash they’re saving to better use. They are doing a much better job staying current on financial obligations like mortgages and especially credit cards (credit card delinquency rates are at record laws). And they’re saving a lot more money. The savings rate was a very strong 5.6 percent in October. In 2013, Americans saved $589 billion, or 4.8 percent of their incomes. This year, Americans are on track to save about $680 billion, more than 5 percent of their incomes. These developments are really good news for millions of individual Americans, for the financial system, and for the economy at large.

So why isn’t the collapse in oil prices playing as good news? A couple reasons. First, the pain caused by low oil prices is highly concentrated, while the gains are spread more thinly. Second, the gains aren’t always shared quickly. When oil prices spike, companies hasten to pass the costs along in the form of higher prices and fuel surcharges. When the reverse happens, the savings are slower to get passed through. Airlines aren’t exactly rushing to chop fares now that the price of the stuff that accounts for up to 30 percent of their costs has been cut in half.

The real issue is the particularly American characteristic that makes our booms so much more fun and our busts that much more painful: leverage. When sectors get rolling, they tend to borrow a ton of money. Between 2010 and the beginning of 2015, U.S. oil and gas companies boosted their combined debt from $128 billion to $200 billion, the Wall Street Journal reported. So when prices fall, what happens? The underlying business of the oil and gas complex falters, employees lose wages, and shareholders see their dividends reduced. That’s all bad. But leverage and debt is the way that optimism—and then pessimism—is socialized and goes viral. Energy-related debt winds up the balance sheets of pension funds, mutual funds, individual investors, hedge funds, and especially banks—many of which have borrowed against those positions. Defaults can trigger liquidations and further defaults. So as was the case in the mortgage debacle, a few defaults can have effects that are widespread, immediate, and highly visible.

This is not to dismiss the carnage in the oil patch that is seeping into the broader financial system. But as we shed tears for oil-trading hedge funds and junk bond funds being forced to liquidate after making ill-timed bets on energy companies, we should share a smile for the typical American consumer who’s enjoying the benefits of really cheap oil.