Australians like to think they live in the “lucky country” but that label is surely better applied to the US today. You could hardly envisage a more benign backdrop for the US economy and stock market than the current environment of tumbling energy prices, low inflation, narrowing deficits, competitive industry, a popular currency and, consequently, lower-for-longer interest rates.
The frantic shuttle diplomacy in the run up to the recent OPEC summit in Vienna illustrated the pain being felt by the world’s less-favoured nations – those like Venezuela and Russia that simply can’t balance budgets at a $US75 oil price. The meeting showed how difficult it can be to persuade countries, even members of a supposedly co-operative cartel like OPEC, to work together if doing so runs counter to their self-interest.
It may be beneficial to OPEC as a whole to curb production in the face of surging US shale oil output and flagging global energy demand, but member countries may rationally decide it is better to keep the oil flowing to protect their market share.
Cheap crude
If you have built up enough foreign reserves in the good years (as Saudi Arabia has) and you want to make life tough for your new rivals in the marginal oil fields of North Dakota, you might feel a couple of years of cheap crude is a price worth paying.
The excess supply created by the US shale revolution has been disguised in recent years by capacity reductions in war-torn countries like Libya. But the producers’ luck has run out this year as supply has picked up around the world even just as China’s slow-down and stagnation in Europe and Japan reduced demand.
The jockeying for position by Saudi Arabia and others might sound like a game but it really matters. With world oil exports amounting to around 40 million barrels a day, the $US40 drop in the oil price since June represents a transfer from oil exporters to oil consumers of more than US$400 billion or so a year. US consumers have an extra $US70 billion in their pockets. Money they used to spend on fuel and can now direct towards eating out, buying the latest electronic gizmo or going on holiday.
Confident consumers
Even with the usual lag before consumers see the benefit of falling petrol prices, we are starting to feel the impact. US economic growth reaching an annualised 3.9 per cent in the third quarter was in part a reflection of more confident consumers with higher disposable incomes.
With consumption accounting for two thirds of the US economy, this is one key benefit of the oil price slide. But it is not the only one. Cheap energy is rapidly replacing cheap labour as the key differentiator between countries competing for investment in a global marketplace. As emerging markets’ wage bills rise, the US’s energy advantage becomes ever more significant. Europe, which missed out on the first big shift, looks like being squeezed as badly by the second. No wonder companies like BASF are choosing to build any new chemical capacity on the shores of the Gulf of Mexico and not the banks of the Rhine.
The third key benefit of cheap oil for the developed world, and the US in particular, is the downward pressure it applies to an inflation rate that might otherwise have picked up on the back of a recovering housing market and falling unemployment. Low inflation is providing the cover needed by central banks like the Federal Reserve to keep monetary policy much looser for longer. Even when rates do start to rise, probably in the middle of next year in the US and later still in the UK, the trajectory will be shallower and the end point lower in a world of cheap energy.
Unqualified good news
Of course, the falling oil price is not unqualified good news. There is many an over-borrowed US oil-drilling company that took advantage of super-cheap debt in the junk bond market and is now wondering how it will pay the coupon. Energy companies now represent 16 per cent of the US high-yield bond market compared with 4 per cent a decade ago. Trouble in the junk bond market can spell trouble for the stock market.
But that is a problem for another day. In the short term, the US market’s string of new highs is a logical response to the emergence of the new lucky country.
