Christmastime socializing, oil patch style, was one of the first casualties of the collapse in energy prices that began last summer. It was December 2014 and an eviction notice had been served at 413 Main Street, Williston, North Dakota. The occupant, for all of 12 of the prior months, had been The Bakken Club, a limited-member social and business club which featured a bar and a restaurant. It’s sort of feasible that West Texas Crude (WTI) commanding $110 a barrel justified the cost to cavort. Individual memberships started at $5,000 initiation with $3,000 annual dues. Corporate memberships, which commanded a $15,000 one-time fee and $9,000 annual dues allowed three additional members to be included in the camaraderie. How very generous indeed.
That is, until oil fell out of bed. Something about that 46-percent decline from 2013’s to 2014’s Christmas Eves rendered the Club’s business model inoperable. The above referenced holiday-affronting eviction arrived before those poor souls on the blustery plains could even ring in the New Year. I’m just guessing here, but something tells me the initiation fee return-on-investment didn’t pan out the way the inaugural and final members envisioned.
The Bakken Club may have been one of the first oil-infused establishments to fold, but it certainly wasn’t and won’t be the last, not with the price of WTI dipping below the $40-level; it’s now down a further third from its 2014 closing price. A seminal piece of research produced by Deutsche Bank (DB) economists at the turn of the year resolved a good bit of the “conundrum” that’s kept economists scratching their heads. Why in Sam Hill have households not spent the resulting gasoline price windfall in an aggressive manner?
The DB team endeavored to gauge the potential economic blowback by estimating first the excess economic benefit the U.S. economy had enjoyed since 2006 thanks to the 12 states that benefitted most from the shale revolution. As of the end of last year, the U.S. energy sector was a $1 trillion annual industry with $250 billion in new capital expenditures and $700 billion in annual expenditures related to materials, labor, taxes and financing costs. DB’s analysts estimated that the annual pullback in capital expenditure plans – not current spending that can’t be curtailed – amounted to 30 percent of the $250 billion in existing plans, or $75 billion a year in lost economic output, or gross domestic product (GDP).
But that’s just half the story that’s led the economy to the precipice of the slippery slope on which it’s precariously perched. The number and quality of jobs created really digs down into the black gold the economy has pumped in recent years. According to DB, the furious quest for shale resulted in two million more jobs being created than otherwise would have been the case. More importantly, in this world where wages are as flat as Queen Isabella thought the world way back when, average wages would be $1.10 per hour lower in shale states had they grown at the national rate since 2006. Tally the dollar value of these two critical components and you get to an exceptional excess of $130 billion per year. Assuming (with the recollection that this math was done $25 a barrel ago) a 30 percent decline in this excess gets you to a $40 billion cutback.
Marry together the troublesome three -- foregone capital expenditures, lost job creation and missing higher wages -- and you get to $115 billion per annum as a starting point. Bear in mind, this hit does not incorporate the nasty economic side effects that accompany reduced shale drilling. We’re talking about lower consumption of electricity and production inputs such as steel, water, and chemicals, to say nothing of reduced demand for housing, and lest we forget, social club fees and annual dues.
To be absolutely sure, as I’m pleasantly reminded every time I fill up my gas-guzzling SUV, there’s been a tremendous and immediate benefit to drivers all across America. Economists putting pen to paper arrive at savings of around $120 billion annually. While that’s nothing to sneeze at, DB concluded that, “The benefits of lower energy prices are likely to be largely offset by costs associated with sector readjustment.”
As sure as today’s less convivial night follows tomorrow’s lower production day, Goldman Sachs recently commented on the latest “surprisingly” lackluster wage report: “Declines in wage growth in the shale states have been larger than changes in their unemployment rates would imply, reflecting both the sharp drop-off in wage growth in the mining sector and possibly also the reduced earnings that former energy sector workers are likely to face outside of the sector.” For the record, earnings at private employers were growing at a 2.1-percent rate as of the latest July data, right in line with the average since the current expansion began over six years ago. A separate gauge, the employment cost index, showed that wages grew by 0.2 percent in the second quarter, the measliest gain in over thirty years.
You may note the Goldman comment mentions the mining sector. Make no mistake, outside the perceived safe-haven of gold, commodities from aluminum to iron ore to steel to zinc are scraping 16-year lows. By that yardstick, throwing in agriculture for good measure (the Bureau of Economic Analysis does not separate out mining just yet – perhaps we are returning to an agrarian age, which would render those data-meisters visionaries), Wyoming is the most exposed state. Some 36 percent of the Cowboy State’s economy depends on agriculture and mining. The top ten list is rounded out, in order of dependence, by Alaska (27%), North Dakota (21%), West Virginia (18%), Oklahoma (16%), Texas (15%), New Mexico (12%), South Dakota (10.4%), Louisiana (10.1%) and Montana (9.8%). Another six states’ economies are at least six-percent dependent on the sectors compared to 3.9 percent for the nation as a whole.
Or, let a recent Liscio Report map do the talking. Here's inflation-adjusted wage growth in manufacturing around the country, both from the 2009 wage trough and the 2010 peak. In terms of wage growth it matters, a lot, if you're sitting on valuable natural resources. (Note to the gimlet-eyed: slightly different definition of "rig states" in this exercise, which has no effect on the overall point.)
My labor market guru and new partner Philippa Dunne’s latest communications with shale state revenue officials back the wage malaise story with lamentations that energy patch jobs are being replaced with positions in the leisure and hospitality industry. The retail sales and mall traffic data provide further validation – while back to school sales are up over last year’s, bargain hunting still rules the day. The one area middle class families are letting loose with their pump price savings is eating out. The problem with jobs being created that require the ability to take a BLT order is that each server-job created generates an annual income of between $7,000 and $35,000. But slice that paycheck range right down the middle and a given wait staff’s annual take, including tips and what few perks are on offer, is about $21,000. That level of income can’t hold a candle to even the lowest paying oil patch job where salaries tend to start in the $75,000-range.
The above picture, of course, only captures what’s going on inside U.S. borders. Although some policy makes, including within the FOMC, may think that policy can be set in a vacuum, the uncomfortable truth is that the rest of the world matters – like a whole lot. Heading into the year, the general consensus was twofold. 1) The economic benefits of falling oil prices would outweigh the costs (see above). 2) The U.S. economy, and other oil importing nations, would be largely indemnified from the pain felt in beleaguered commodity exporting countries such as Brazil, Chile, Russia and Venezuela, to name but a few.
Closest to home, Canada and Mexico are both seeing their economic waters roiled by the double whammy of falling energy prices and its close compadre, the strengthening dollar, which both pressure downward export revenues and push higher imported goods prices for domestic consumers. Both the Canadian loonie, smarting at an 11-year low to the dollar, and the Mexican peso, which has crashed to a record low, reflect the downward stress being exerted on those countries’ economies. Stories of cratering cross-border sales to the south and rising mortgage delinquencies to the north increasingly populate the headlines.
But the real story is China, whose currency was, until recently, pegged to the U.S. dollar. When you’re in the business of dumping all manner of commodities on the world markets, that peg can start to feel more like a thorn in the side. As anyone anywhere on the planet is now fully aware, the most miniscule of devaluations can catalyze contagious calamities, at least in the financial markets. At the risk of being overly simplistic, the further the Chinese yuan falls against the dollar, the more the dollar is pressured upwards and hence, other countries’ currencies woes are magnified.
Stepping back, there’s no such thing as a win-win in currency wars exacerbated by the unwinding of one of the most magnificent speculative bubbles of all time. For any who doubt commodities were in a bubble, or worse, believe oil at these levels is the buying opportunity of a lifetime, I’ll share with you some parting thoughts care of New Albion Partners’ Brian Reynolds. The commodities bubble began to deflate towards the end of 2013. At that same time, pensions, desperate for a hedge against the threat of inflation accompanying the Fed’s last (failed) stab at tightening monetary policy, were players too big to buy directly into the commodities markets due to position limits. So they turned to their all-too-amenable Wall Street bankers to devise a way to obtain said inflation protection via the derivatives market. Before all was said and done, there were an estimated $2.3 trillion of these securities outstanding backing ten times that level of underlying commodities.
In other words, the Street, in its infinite avarice, was able to create securities worth multiples of the value of the underlying assets (if that theme elicits a feeling of deja vu, it’s because bankers did the same thing in cycles past with fiber optics and subprime mortgages). Once the unwind of these trades was triggered by this or that commodity hitting the lower contracted bound, an avalanche of money broke the dams, flooding out of the sector and befuddling market veterans. As Brian summed up: “Few analysts in those sectors grasped that the structuring dwarfed the physical supply and demand for those assets.”
If there’s one thing I learned during my time on Wall Street during dotcom mania, it’s that once bankers’ sights have shifted to a new target, their past darlings never return to favor. There will be no saving grace for the commodities complex. The Bakken Club, and the boost to economic growth and conviviality it personified, ain’t coming back any time soon.