Download US Consumer and Corporate Behavior in a Low Oil Price World

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US Consumer and Corporate
Behavior in a Low Oil Price World
Ronald Temple, CFA, Managing Director, Portfolio Manager/Analyst
David Alcaly, Research Analyst
Since the extraordinary decline in oil prices that began in mid-2014, analysts and commentators have focused much of
their attention on who wins—and who loses—from cheaper oil. What has not been a subject of much analysis, however,
is timing—when the impact of lower oil prices will actually appear in the economy. This question is of great importance
to the United States, which is both a large oil producer and a net importer.
In this paper, we examine how and when sustained lower oil prices may affect US consumer and corporate behavior.
Consumers have already seen dramatically lower gas prices at the pump, but we believe higher spending is unlikely to
occur until the second half of 2015. Corporate cuts in the US energy industry, on the other hand, are being announced
now, and their impact will be felt as they are implemented. Considered together, we believe that the decline in energy
prices is a substantial net positive for the US economy, but we also recognize that the benefits and damage may not
appear in the economy at the same time.
2
Introduction
In the December Lazard Insights, The Evolving Global Oil Market,
we evaluated the factors contributing to plummeting oil prices and
outlined the implications of a low oil price world. In a series of Letters
from the Manager since, our investment teams have discussed the
specific implications for investors in the Middle East and North Africa
(MENA), Australia, real estate, and emerging markets debt. In this
paper, we examine how and when the decline in oil prices may affect
consumer and corporate behavior in the United States.
It is commonly observed that two of the biggest economic impacts of
sustained lower oil prices should come on the positive side from new
consumer spending due to savings at the pump, and on the negative
side from capital expenditures (capex) and job cuts by companies in
the oil supply chain resulting from sharply lower cash flows. Winners
and losers are thought to break down along the same consumer and
producer lines (Exhibit 1).
Exhibit 1
Winners and Losers from Lower Oil Prices
Winners
Losers
Countries
Net importers
Net exporters
Industry
Sectors
Petroleum or
related inputs
Petroleum or
related outputs
Exposed to consumer
discretionary spending
Exposed to the oil
production supply chain
prices were to recover. While they are not discussed in this paper, we
also believe that state and local governments in oil-producing regions
will take even longer to adjust, both because their budgeting cycles are
not designed to respond rapidly and because, with the exception of
Alaska, tax revenue likely will be affected more by weaker local economies than by lower oil production taxes.
Consumer Spending
At the current average retail price for regular gasoline of $2.33 per
gallon,1 consumers stand to save roughly $830–$1,020 per household
on gasoline over the course of a year (Exhibit 2), or about $105–$125
billion cumulatively. The impact of this windfall on the economy
depends on how much of it is spent rather than saved.2
Exhibit 2
Lower Gas Prices Could Result in Significant Savings
for Households
(USD/Gallon)
3.8
Average Gasoline Price
2014 Average
2.9
Estimated Consumer Savings
Price Drop vs. 2014 Average ($/gallon): 1.08
Implied Consumer Savings ($B): 105–125
Implied Savings per Household ($): 830–1,020
2.0
Feb 14
Apr 14
Jul 14
Sep 14
2.33
Dec 14
Feb 15
As of 23 February 2015
The timing of the gains and losses from oil prices is less obvious. This
consideration is particularly important for the United States, a net
importer of oil that is also one of the world’s biggest oil producers. We
agree with the consensus that low oil prices should be a net positive for
the overall US economy, with differing regional and sectoral impacts.
However, we disagree about timing and believe current expectations
about how quickly these impacts will be felt are unreasonable.
We believe the most substantial portion of increased consumer spending is likely to become apparent three to four quarters after prices
began to decline. This implies that the expectations for a spike in consumer spending in the first half of 2015 might be premature. In fact,
we believe there is a strong case to be made that the bulk of consumer
spending benefits will come in the second half of 2015 as household
savings accumulate and people begin to see lower fuel prices as a longterm rather than a short-term change in expenses.
We believe imminent corporate cuts are more widely anticipated
because of recent announcements, which have come quickly and are
severe. They should be followed by more gradual signs of wider economic impact, as cuts are implemented and local economies suffer. The
speed and depth of these announcements can partially be explained
by the quicker capex cycle for shale oil production, which also implies
that capex could be ramped back up more rapidly than in the past if oil
Note: Chart shows the drop in average retail prices for regular gasoline. Consumer
savings calculation is based on spending on all grades of gasoline and fuel oil.
Forecasted or estimated results do not represent a promise or guarantee of future
results and are subject to change.
Source: Energy Information Administration, Bureau of Economic Analysis, Census
Bureau, Bureau of Labor Statistics, Bloomberg, Haver Analytics, Lazard
It is important to note that consumer spending on gasoline and other
fuel contributes to GDP. As a result, if consumers save rather than
spend their entire windfall from lower gasoline prices, GDP measured in
dollars, as opposed to volume, could actually decline. When the benefits
of lower fuel prices are instead spent on other goods and services, there is
a stronger multiplier effect than if these benefits had been spent on fuel.
This elevated multiplier effect means the new spending ultimately has
an even greater impact as increased business revenues resulting from this
spending are in turn spent and work their way through the economy.
Much of the discussion of the economic impacts of lower oil prices has
focused on headline consumer savings, leading to recent disappointment
that retail sales have yet to show dramatic improvement (Exhibit 3). Part
of the problem is that it is inherently difficult to separate the impact of
new spending from the broader dynamics of an improving economy.
Moreover, retail sales figures do not capture all consumer spending
and are themselves affected by the lower prices at the pump. While the
Department of Commerce does report retail sales at gasoline stations as
3
If we take into account the damage done to consumer balance sheets,
income statements, and confidence by the global financial crisis, it is
appropriate to expect consumers to be more reluctant to spend all of
their savings right away. In fact, in a recent fourth quarter earnings
call, Visa CEO Charles Scharf indicated that consumers to date have
been saving about 50% of the energy windfall, using another 25% to
pay off debt, and spending only 25% on other goods and services. He
also said that he anticipated that accumulated savings would eventually be spent in discretionary categories.
Exhibit 3
Retail Sales Have Not Responded Dramatically to Lower
Gas Prices*
(%, MoM Change)
1.2
0.6
0.0
-0.6
-1.2
1994
2001
2008
2015
* Retail sales include food services but exclude autos, building supplies, and gas
stations; month-over-month % change, 3-month rolling average (SA).
As of 31 January 2015
Source: US Department of Commerce, Haver Analytics
a separate series, the percentage of gasoline purchases from sources other
than gasoline stations has risen to 13.8% of total volume as companies
like Kroger, Walmart, and Costco sell increasing volumes of gasoline.3 As
a result, even core retail sales figures are not as clean as they might appear.
Beyond measurement challenges, two other factors should be taken
into account:
1. the possibility of a lag in how consumers respond to changes in
expenses that are more price inelastic; and
2. the timing and accumulation of savings.
We see this lag as shaped by a number of factors that influence consumer behavior, including:
• the propensity to spend new disposable income, which is highest
among low-income consumers;
• the economic and employment outlook;
• views on the duration of low gas prices, especially since new volatility in prices (which were relatively stable in recent years) increases
uncertainty, creating a bias for saving; and
• the lasting psychological impact of losses incurred in the global
financial crisis, as well as the related need to continue deleveraging
and rebuilding household balance sheets.
Our view is that while consumers immediately recognize their savings at the fuel pump, they are unlikely to immediately commit to
redeploying their incremental disposable income in a long-lasting way.
For example, if an individual saves $20 on gas, she might splurge on
a movie or a restaurant meal or might choose to save the money. She
is unlikely, however, to commit to monthly payments for a durable
goods purchase under the assumption that the savings on fuel will be
recurring. Over time, as the energy savings are perceived to be more
“permanent,” then we would expect an individual to redirect her savings in a more long-term way, leading to increased consumption of
other goods and services that initiates the virtuous cycle of multiplier
effects we anticipate.
We believe improving sentiment, continued job gains, and an
accumulation of savings could come together in the third or fourth
quarter. Notably, US gasoline consumption peaks during “the
summer driving season,” and the combination of summer vacations
followed by the back-to-school shopping season provides ample
opportunity for increased discretionary spending. We should also note
that by late 2015, many consumers will begin to see their credit scores
recover from the financial crisis. Credit scores typically take about 7
years to recover after a foreclosure and 7–10 years to recover following
a bankruptcy, depending on its type.4 Over the course of 2015, more
than one million households could see their credit scores recover as the
extreme financial stress of 2007–2009 recedes into history. Combined
with lower fuel prices, stronger job gains, and still low interest rates,
this could be particularly powerful in driving increased spending.
We illustrate the accumulation of savings per household in Exhibit 4, in
which we chart monthly year-over-year changes in actual US consumption of fuel oil and motor gasoline multiplied by retail prices through
January 2015. We extend the calculation to the end of 2015 using
consumption and prices as projected by the US Department of Energy,
Exhibit 4
Household Savings Projected to Peak in Spring and
Summer 2015
(YoY Change, USD Spend Per Household)
40
(USD)
4.0
EIA Projection
Actual
0
3.5
-40
3.0
-80
2.5
-120
-160
Jun 14
Sep 14
Gasoline [LHS]
Dec 14
Mar 15
Fuel Oil [LHS]
Jun 15
Sep 15
2.0
Dec 15
Avg Gasoline Retail Price [RHS]
As of 31 January 2015
Note: Calculated as (consumption x retail price) / number of households.
Consumption data is not limited to households. Price and consumption projections are those of the Energy Information Administration. Savings are not evenly
distributed among households. Forecasted or estimated results do not represent a
promise or guarantee of future results and are subject to change.
Source: US Energy Information Administration, Lazard
4
Exhibit 5
Exploration and Production Capex Cuts Could Be Similar to 1986
Down Years (%)
North America Capex
1986
1987
-39
-8
1991
3
1992
1998
-18
-4
1999
2002
2009
2015E
-27
-17
-32
-35
International Capex
-18
-4
23
8
14
-14
9
-6
-15
Total Capex
-31
-6
15
-2
7
-18
-1
-15
-21
Lazard estimates as of 17 February 2015. Forecasted or estimated results do not represent a promise or guarantee of future results and are subject to change.
Source: Historical data from Barclays
which sees pump prices rising slightly but remaining near current levels.
The calculation is rough, but it nonetheless demonstrates that meaningful savings only began in recent months. As shown in the chart, we
expect savings to be substantially larger in the spring and especially the
summer, with cumulative savings reaching significant levels during
this period. Assuming prices do not sink further, year-over-year savings
should decline as we approach the anniversary of the initial energy price
decline in the fourth quarter.
In summary, we believe the shift in spending from lower oil prices to
other goods and services is likely to be delayed longer than in prior supply-driven price cycles due to the circumstances of the current economic
environment, potentially until the third or fourth quarter of 2015. The
benefits will extend into 2016 assuming fuel prices do not rebound, but
that contingency largely depends on the pace and degree of capex reductions by oil producers and the subsequent effect on prices.
Oil Supply Chain Cutbacks
In contrast to the more nebulous task of evaluating and projecting
consumer behavior, we have already seen immediate and substantial
announcements of capex cuts by energy companies in response to the
oil price decline.
Based on historical experience and assuming oil prices remain near
current levels, we believe the 2015 cuts could reach 35% versus
2014 capex, which represents a significant drop in historical terms
(Exhibit 5). Only five times previously has the oil price plunged more
than 30% in a six-month period. Four of these instances coincided
with global weakened demand for oil, during the US recessions of
1990–91, 2001, and 2007–09, and the Asian crisis in 1997–98. The
fifth, in 1985–86, is most similar to current circumstances and was
precipitated not just by weak demand growth due to price spikes in
the 1970s, but also by supply factors—rising production from nonOPEC sources and a reversal of policy by Saudi Arabia, which ramped
up production to gain market share (Exhibit 6).5 Following the
1985–86 price decline, North American exploration and production
capex dropped by nearly 40%, according to Barclays data.
Our estimate of a 35% capex cut in 2015 represents a small further
decline from already announced spending cuts, which have been rapid
and severe in the first quarter to date, averaging 30% for US producers
Exhibit 6
Major Oil Price Declines Since 1983
(USD/Barrel)
140
105
70
35
5/01–11/01
-32.2%
10/90–4/91
-47.0%
10/85–4/86
-58.0%
0
Jul 83
7/14–1/15
-55.2%
10/97–4/98
-33.5%
6/08–12/08
-68.6%
Jan 94
Jul 04
Jan 15
Avg of WTI, Brent, and Dubai Spot Prices
US Recession
As of 31 January 2015
Note: Price drop percentages are for the deepest six-month drop in an average of the
monthly average WTI, Brent, and Dubai spot prices.
Source: Bloomberg
and 34% for Canadian producers based on Goldman Sachs tracking
through 19 February 2015. Announcements in recent weeks included:
• ConocoPhillips, slashing spending plans twice in a month, including a 30% cut to worldwide capex;
• Pioneer Resources, surprising the market with 45% year-over-year
capex cut; and
• Apache, announcing that it would reduce 2015 spending by 55%.
The timing of these announcements, roughly two quarters after the oil
price began its plunge, is also in line with past experience. Historically,
a decline in rig counts, which foreshadows new drilling, lags falling
oil prices by about one quarter, while private fixed investment in oil
& gas wells and mining & oilfield machinery lags prices by about two
quarters. Indeed, rig counts have begun to fall off dramatically (down
39% from the 10 October 2014 peak as of 27 February 2015),6 but
upstream private fixed investment was still increasing at the end of
2014. Similarly, direct employment in upstream oil & gas production
had yet to decline significantly by the end of 2014 (Exhibit 7).
The severity and speed of these announcements is in part due to the
rapid growth of shale oil production in recent years, as its capex cycle is
shorter than for other oil production, especially large, complex multi-year
projects offshore. To be more specific, a significant portion of oil shale
well production is generated in the first two years, and production rates
can decline 70% in the first year.7 The time to initiate production is
5
Exhibit 7
Rig Counts Have Started to Follow Oil Prices Lower...
(USD/Barrel)
60
(Rigs)
3,000
WTI Crude Oil Inflation-Adjusted
Spot Price [LHS]
Baker Hughes US Oil & Gas
Rotary Rig Count, Pushed Back
3 Months [RHS]
45
2,250
30
1,500
15
750
0
1983
1991
1999
2007
0
2015
As of 27 February 2015
Note: The rig count series is for both oil & gas rigs, which extends back further than
the equivalent series for oil rigs alone and captures the 1985–86 price drop.
Source: Baker Hughes, Bloomberg, Haver Analytics
...While Upstream Fixed Investment Lags the Oil Price by
Two Quarters...
WTI Spot Price
Upstream O&G Private Fixed
Investment, Pushed Back
Two Quarters
80
1986
1993
2000
2007
2014
As of 31 December 2014
Source: Energy Information Administration, Bureau of Economic Analysis, Haver
Analytics
...And Oil & Gas Employment Has Yet to Significantly Decline
(% MoM Change)
3
0
Upstream Oil & Gas Employment
Total Oil & Gas Employment
-3
2007
Nonetheless, recent announcements clearly signal the beginning of
deep cuts to investment and employment, which we expect to be felt
throughout the oil production supply chain as they are implemented.
However, the broader negative impacts on regional and local economies
will take longer to be felt even if sentiment might be affected sooner.
Conclusion
0
-80
Balancing quicker reaction times, many of the initial cuts in shale capex
have been focused on less efficient and more costly new development, and
some of the capex reductions will come via lower prices and margins in the
supply chain, making impacts more gradual than headlines suggest. This
view is consistent with the consensus that while US oil production growth
will slow, a decline is unlikely to occur at least until the second half of
2015 or even later, depending somewhat on whether prices remain low for
an extended period of time or enter a “V-shaped” recovery. Notably, when
natural gas prices and rig counts fell in 2012, gas production did not.
In summary, we believe the scale and timing of recent rig count
declines and capex cut announcements are in line with historical
experience and their economic impacts are likely to be felt in coming
quarters. Based on historical experience, oil production capex could
ultimately sink by 35% or more. However, capex cuts for shale oil
production can be reversed more quickly if prices rebound.
(%, YoY Change)
160
also short, allowing producers the flexibility to adjust capex plans quite
quickly (aside from investments that have been contracted in advance),
both as prices plunge and as they recover (provided prices do not stay
down so long that spare capacity shifts out of the supply chain).
2009
2011
As of 31 December 2014
Source: Bureau of Labor Statistics, Haver Analytics
2013
2015
The potential effects of the recent plunge in oil prices have been the
subject of much discussion, in particular the benefits for consumers
and consumer spending and the negative impact on oil producers and
the oil production supply chain. Despite wide anticipation, we believe
consumer impacts will become most apparent in the second half of the
year and producer impacts in coming quarters, assuming oil prices do
not rapidly rebound.
We estimate consumer savings of roughly $830–$1,020 per household
and producer capex cuts of roughly 35% in 2015, with wider effects
as new consumer spending circulates throughout the economy and
lower oil producer spending hurts the industry supply chain and
local economies reliant on oil production. However, both direct and
indirect effects will take time to be felt. On the positive side, consumer
behavior is likely to gradually factor in more “permanent” savings and
a stronger economic outlook, but it will take time for sustained consumption patterns to change as the majority of savings will accumulate
in the spring and summer. On the negative side, recent rig count
declines and capex announcements signal the beginning of actual cutbacks, based on historical experience.
Taken together, we view the decline in energy prices as a substantial
net positive for the US economy, but we also recognize that the costs
of capex reductions will be uneven and may not perfectly match the
timing of the benefits from consumer spending.
6
References
1 As of 23 February 2015. Source: Energy Information Administration
2 The upper end of the range is calculated using Personal Consumption Expenditure information from the Bureau of Economic Analysis’s National Income and Product Accounts. The most
recent release was the advance estimate for 2014, published on 30 January 2015. The lower end is calculated using household expenditure information from the Bureau of Labor Statistics’s
Consumer Expenditure Survey (CE). The most recent CE data tables are for 2013 and were made available on 9 September 2014.
3 2015 Retail Fuels Report. National Association of Convenience Stores. February 2015.
Spittler, Malcolm D. and Peter D’Antonio. Retail Sales Through The Looking Glass: Down is Up. 12 February 2015.
4 As of 13 February 2015. Source: Fair Isaac Corporation, MyFICO.com
5 Global Economic Prospects, January 2015: Having Fiscal Space and Using It. World Bank Group. January 2015.
6 As of 27 February 2015. Source: Baker Hughes United States Crude Oil Rotary Rig Count data via Bloomberg
7 Jayaram, Arun and Mark Lear. Investing in E&P. Credit Suisse, 1 April, 2014.
Important Information
Published on 7 April 2015.
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