Cheap Oil Is 'Bad' for the Economy

It's been about a year since oil prices started their historic drop, falling from above $100 a barrel to a bottom of about $45 in March. After creeping back to around $60, prices are shaky again amid news of a nuclear deal with Iran and record Saudi production.

And low oil prices are good for growth, right?

Cheap oil means cheap gasoline, and the assumption throughout the oil price rout has been that for the U.S. economy, built on consumer spending, cheap gas is all good. In theory, yes. In practice, it's been tough to find the benefits in the economic data this year.

Goldman Sachs estimates that a decline in energy-related investment such as new drilling equipment, caused by low oil prices, subtracted about half a percentage point from economic growth during the first half. That's a pretty hefty bite out of a growth number that probably won't be much higher than 2.5 percent over the first six months of 2015. A note out from Goldman this week suggests that so far the negatives of inexpensive crude oil appear to have outweighed the spur to consumer spending. Goldman forecasts that the drop in oil prices will account for about 30 to 40 percent of the slowdown in economic growth from its annual pace at the end of last year.

The firm reckons that layoffs and a slower pace of hiring in the oil patch have accounted for about 20 percent of the slowdown in total payroll growth so far this year. Through June, the economy has added an average of 208,000 new jobs a month. That's strong but compares with a monthly pace of 281,000 over the second half of 2014. The slump is particularly acute in the shale states of Texas, Oklahoma, North Dakota, Wyoming, and New Mexico, where a decline in drilling activity has spilled over into the broader economy and affected job growth across other industries.

The worst of it appears to be over. Initial jobless claims in shale states have declined after a significant spike during the first months of the year. Layoff announcements from energy companies aren't quite as frequent or as large as they were back in the winter and spring. The total oil rig count in the U.S. as measured by Baker Hughes has stabilized over the past month at around 860, after falling by more than 50 percent since the end of November.

Drilling activity could plummet again, and layoffs begin to pick up, if there's a new selloff in the oil market. The difference between $60 crude and $45 crude is enormous for U.S. oil companies. There's reason to believe that we're on the verge of an M&A boom in the energy sector. While that would be good for the sector's balance sheets, it would probably end up leading to more layoffs.

But that impact would probably be contained in states such as Texas and Oklahoma. Goldman suggests that there is "less reason to worry about broader growth trends—especially as that shock appears to be fading, and the positive effects of lower oil prices on consumption are starting to show through." Americans are driving more miles and buying vehicles at a near-record clip.

The U.S. savings rate remained above 5 percent for the first five months of the year, suggesting that household balance sheets are healthier than they've been in years. The national price of a gallon of regular gasoline has averaged $2.47 through July 13. That's more than $1 cheaper than the average price during the same period a year earlier. Based on the 137 billion gallons of gas consumed in the U.S. last year, that should roughly translate into an extra $137 billion in increased buying power. Recent data have begun to reflect that. In May, consumer spending rose by 0.9 percent, the biggest monthly increase in six years. There is evidence that Americans are spending some of that gasoline savings on leisure items like books and sporting goods equipment.

So while the benefits of low oil prices have taken a while to show up, they are beginning to, just not in a big or consistent way. Americans still appear to be skittish about whether cheap gas is here to stay, so the gains in spending have been spotty, and only recently apparent. Those consumer spending numbers in May didn't flow through to June as strongly as many had hoped. The most recent retail sales figures from the Commerce Department showed U.S. consumers cutting back on purchases last month.