Economic Outlook With Lower Oil Prices
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16 February 2015
Economic Outlook With Lower Oil Prices
Michael P. Carey
Chief Economist - USA
+1 212 261 7134
michael.carey@ca-cib.com
https://catalystresearch.ca-cib.com
Crédit Agricole Corporate and Investment Bank is authorised by the Autorité de Contrôle Prudentiel et de Résolution (ACPR) and supervised by
the ACPR and the Autorité des Marchés Financiers (AMF) in France and subject to limited regulation by the Financial Conduct Authority and the
Prudential Regulation Authority. Details about the extent of our regulation by the Financial Conduct Authority and the Prudential Regulation
Authority are available from us on request.
What led to the oil price decline?
• Softening global demand growth
• Strong US supply growth
• OPEC focus on market share: unlikely to implement production cuts.
Brent Crude Oil Price
(US$ per Barrel
Page 1 16 February 2015 1
Markets gradually rebalance and prices adjust higher
• Modest pick-up in global demand
2014 +0.9 MMBD +1.0 MMBD in 2015-16
• Non-OPEC supply growth, particularly from the US, slows due to lower prices and
industry investment
2014 +2.1 MMBD +0.8MMBD in 2015-16
• EIA forecasts that Brent crude oil prices will average $58/bbl in 2015 and $75/bbl
in 2016.
Page 2 16 February 2015 2
US Macro Summary Situation
Macro Economic
Road to Recovery
Growth in 2015 is expected at an above-trend pace
near 2.8% Q4/Q4. Many of the headwinds to growth, US Macroeconomic Outlook
such as fiscal drag and household deleveraging, have
abated and declines in energy prices will provide a GDP % 10
%10
GDP Recession
4 4 Recession Forecast
Forecast
strong tailwind.
8
8
Lower oil prices act similar to a tax cut, boosting 2 2
consumer spending, but they are expected to also 0 0 6
6
throttle investment in oil and gas extraction industries.
-2-2 4
4
A stronger USD is expected based on relative growth
and interest rate differentials and divergent monetary -4-4 2
2
policies vis-à-vis our trading partners. US net exports will -6-6
be negative for growth this year. -8 0
0
-8
The sharp decline in gasoline prices is expected to
-10 -2
push the top-line CPI into deflation in the spring and -10 -2
Q1-08
Q3-08
Q1-09
Q3-09
Q1-10
Q3-10
Q1-11
Q3-11
Q1-12
Q3-12
Q1-13
Q3-13
Q1-14
Q3-14
Q1-15
Q3-15
Q1-16
Q3-16
Q1-08
Q3-08
Q1-09
Q3-09
Q1-10
Q3-10
Q1-11
Q3-11
Q1-12
Q3-12
Q1-13
Q3-13
Q1-14
Q3-14
Q1-15
Q3-15
Q1-16
Q3-16
early summer of 2015. Core CPI in 2014 rose 1.7% Unemployment
Q4/Q4 and will likely see mild disinflationary pressures
over the near-term before firming later in 2015. Real
RealGross
GrossDomestic
DomesticProduct
Product(SAAR,
(SAAR,%Chg)
%Chg)
Civilian
CivilianUnemployment
UnemploymentRate:
Rate:16
16yryr++(SA,
(SA,%)
%)
The January labor market saw broad-based CPI-U:
CPI-U:All
AllItems
Items(SA,
(SA,1982-84=100)
1982-84=100)% %Change
Change- -Year
YeartotoYear
Year
improvement with greater-than-expected payroll
employment growth (+257K) with an unemployment rate Source: BEA, BLS, Haver analytics, Credit Agricole CIB
of 5.7%. Over 1 million jobs were created in the past
three months. January wage growth rebounded to
2.2% yr/yr.
Page 3 16 February 2015
US Economic Outlook Positives, Negatives
+
Decline in US gasoline prices Near-term disinflation and higher real disposable income
Robust gains in payroll employment
Lack of fiscal drag Possible fiscal stimulus?
Exceptionally accommodative monetary policy (to be gradually removed)
-
Global weakness, US net exports suffer from soft foreign demand and a stronger dollar
Negative impact on US oil and gas extraction sector
Strong dollar: foreign earnings translation effect on equity markets
Hourly earnings growth remains soft, labor market slack remains
Tight access to mortgage credit
Global and regional political pressures: Voter dissatisfaction Increased political
uncertainty increases risks of expedient (but bad) policies and instability.
?
Fed hikes prematurely
Greater access to mortgage credit
External growth falters/ deflation threat/ financial fragility
Tightening tantrum
Page 4 16 February 2015The boost to consumer spending from lower energy prices
The average household is now expected to spend about $750 less on gasoline in 2015
compared to last year because of lower prices.
EIA expects U.S. regular gasoline retail prices, which averaged $3.36/gal in 2014, to average
$2.33/gal in 2015 and rise to $2.72/gal in 2016.
Consumer spending impact will take time to show up in the figures. The cumulative effect could
take 4-6 months to show up in spending patterns. Restaurant spending likely affected before other
retail outlays. Different regional impacts.
Estimates vary, but for the US a $50 per barrel drop in oil prices could boost the level of GDP
by 0.6% to 1% over the next year or two. Caution is advised as estimates are sensitive to
assumptions on how long prices will remain low and whether the price decline reflects a demand or
supply shock.
Bank of Canada sees 1% higher US GDP by 2016. Blanchard and Gali (cited in a December 2014
IMF study) find that “the effect of a permanent (supply driven) decrease in the price of oil by 10%
leads to an increase in U.S. output by about 0.2 percent.” That would point to a 0.7% boost to
output. Such estimates offer some guidance on the magnitude of the impact but
The boost to real disposable incomes also reflects broad disinflationary effects, such as lower
transposition costs for non-energy goods and services
Lower input costs would be a positive for many firms, potentially boosting profits and non-
energy investment.
Gasoline prices are very visible for households and a price decline that is anticipated to last
for some time tends to boost consumer confidence---another support for spending growth.
Page 5 16 February 2015The downside of lower energy prices: Capex
There is a negative impact of lower energy prices from declines in oil & gas exploration
capital spending and related services.
Estimates we find credible suggest producers could cut capital expenditures by 30% in
2015. We estimate the direct impact would trim about 0.2 percentage points from
GDP growth over 2015.
However, higher-cost producers have been successful in wringing additional efficiencies out
of production costs and they will intensify efforts to lower break-even costs.
250000
Capital Expenditures on Oil and Gas Activities
200000
150000
100000
50000
Millions of Chained 2009
Dollars, SAAR
0
80 85 90 95 00 05 10 15
Source: Bureau of Economic Analysis, Haver
Source: Energy Aspects, Bank of Canada Monetary policy report.. Jan 21 2015, P3
Page 6 16 February 2015The downside of lower energy prices: 1986 redux? Oil and gas extraction and support activities employ less than ½ of 1% of total US nonfarm payrolls and last year created roughly 42K jobs, or 1.3 percent of the total 3.1 million jobs created. The employment multiplier in the oil and gas industry is estimated to be around 2.4, as other industries that provide goods and services to oil and gas companies could see layoffs. In 1986, O&G extraction employment fell about 16% by the end of the year. A similar percentage decline might trim 100K people from energy-related payrolls this year- still relatively small in a labor market that has added 267K jobs per month in 2014 and over one million jobs in the past three months alone. In 1986, real GDP slowed to 3.5% from 4.2% in 1985. However, the underlying health of the economy then was different from now given the impact of the S&L crisis in the mid-to late 80s. The Fed eased rates in 86 as inflation decelerated. Page 7 16 February 2015
The impact of lower energy prices for Fed policy We believe the reduction in labor market slack continues to push the FOMC further along the road towards rate normalization. However, the Fed continues to miss its inflation objective. “Inflation has declined further below the Committee's longer-run objective, largely reflecting declines in energy prices.” We believe that the Fed will judge near-term headline deflation as transitory and focus on core inflation when setting policy. Near-term core CPI will likely be damped by some pass-through of lower energy prices; transportation costs (airfares) and some imported goods, such as clothing, would be affected by the strengthening dollar. Nonetheless, we look for core inflation to firm later in 2015 as the economy strengthens but still fall short of the Fed’s 2% target this year. If the data play out the way we expect, the Fed could begin to gradually raise interest rates beginning as soon as the third quarter of this year Page 8 16 February 2015
The impact of lower energy prices for financial markets
Equity markets
In terms of S&P 500 EPS last year, the energy sector contributed about 11%.
The S&P consensus for 2015 EPS is +5.1% yr/yr with energy -48% and ex-energy +11.8%. *
The S&P has rallied on average 10% in the 12 months following big drops in oil prices since
the mid-70s.
Bond Markets
The energy sector accounts for about 15% of the high-yield bond market.
Lower oil prices weaken energy firms’ balance sheets and lead to tighter credit conditions.
Firms switch to cash conservation mode but some firms will not survive.
Risk already priced in? Signs of stabilization?
Attraction of high-yield bonds in a no-yield world?
*Source Evercore ISI publications
Page 9 16 February 2015Global Outlook
Oil Producers Those oil producers with sufficient foreign exchange reserves can wait out
lower oil prices but others are under extreme pressures ( Saudis vs. Venezuela)
Russia: Severe Recession
● Real GDP set to drop 5% in 2015
with inflation seen rising to 12%.
● Growth and capital flow picture
remain quite negative for 2015.
Econ minister projects $115 billion
capital outflows.
● Rate cut to ease recession. RUB
weakens further.
Page 10 16 February 2015 10Global Outlook
Eurozone macro outlook – weak, not desperate
GDP Growth 1.0%-1.5% in 2015; 1.5%-2.0% 2016
Domestic demand resilient, benefits from lower energy prices (but less of an impact
than in the US)
Fiscal austerity lessened and credit conditions to improve further
Headline deflation likely troughs at around -0.6% in Q1, core inflation running +0.6% y/y
Greece manageable on a reasonable compromise, but political contagion risks remain
ECB QE keeps downward pressure on EUR. EUD/USD forecast at 1.05 at yearend.
Emerging Markets: Big energy importers and/or oil-intensive economies should
benefit from lower oil prices.
Asian EMs better positioned given stronger balance of payment positions compared
with fragile-5 (Turkey, South Africa, India, Indonesia and Brazil). The deceleration of
China’s economic growth is a compounding negative factor for EMs
Page 11 16 February 2015 11Key Conclusions The US will likely be a significant beneficiary of lower energy prices. The impact on the US energy sector and certain regions will be negative but that is overwhelmed by positive real income gains nationally. Fed policy is expected to focus on core inflation and sees the oil price impact as transitory. Financial market impact of weakened energy sector expected to be limited. Many oil importers face other factors that are likely to limit the positive growth impact from the windfall income gains from lower oil prices this year. Oil exporting countries face a range of negative outlooks. Page 12 16 February 2015 12
Certification
The views expressed in this report accurately reflect the personal views of the undersigned analyst(s). In addition, the undersigned analyst(s) has not and will not receive any compensation for
providing a specific recommendation or view in this report.
MICHAEL CAREY
** employee(s) of Crédit Agricole Securities
(USA), Inc.
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