Why lower oil prices can provide a boost to the economy

Much has already been written about falling oil prices. Headlines such as "Oil headed for US$20 a barrel", "Oil sinks 70% in 18 months", have become commonplace.

Brent crude is currently trading around US$31.38 a barrel, half the price it was fetching seven months ago and 70% below where it was in August 2014.

The sliding oil price has been the icing on the cake for miners.
The sliding oil price has been the icing on the cake for miners. 

Surely it must be bad news. Equities markets have certainly taken it as such.

The losers

For shareholders in oil and gas companies it definitely is bad news, particularly those with high costs of production and those yet to get into production - US shale oil and gas producers and deep sea drilling companies like Karoon Gas, I'm looking at you. Many higher-cost producers are likely to bite the dust.

Suddenly oil companies have to find a way to get the stuff out of the ground for much cheaper.
Suddenly oil companies have to find a way to get the stuff out of the ground for much cheaper. 

It's also bad news for oil companies and their employees with big financial losses likely. Suddenly they have to find a way to get the stuff out of the ground for much cheaper prices and much of that is likely to result in hundreds, if not thousands of workers losing their jobs. By extension, that will also affect mining and energy services companies.

But for many parts of the economy, lower oil prices are a blessing in disguise.

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The winners 

For airlines in particular, the fuel bill is the largest expense (after the capital cost of the planes that is). Qantas spent $3.9 billion on fuel in the 2015 financial year, down from $4.5 billion the previous year, and this financial year's bill is again likely to be much lower. Lower fuel expenses have transformed the airline, turning it from a loss making venture to one expected to produce an underlying profit before tax of around $900 million for just the six months to end of December 2015.

Airline ticket prices have also come down as airlines pass on savings from lower fuel costs to customers. Flight Centre recently noted that 8 of the 10 airfares advertised on its main page are 10% lower than in November 2014. Lower prices can also benefit those agents, with more people booking overseas travel.

The fall in oil prices has been particularly good for the aviation industry.
The fall in oil prices has been particularly good for the aviation industry.  

Likewise trucking and transport companies, couriers, taxis, agriculture, shipping, construction and other industries that are high users of petroleum products are likely to benefit. Bulk commodity producers and exporters are also benefitting from lower shipping costs. Some of their savings may also be passed onto customers like the airlines are.

But the biggest winners are likely to be consumers, with lower petrol prices at the pump - despite the Australian dollar buying around US 70 cents currently.

More disposable income usually translates to a pickup in spending.
More disposable income usually translates to a pickup in spending. Photo: Luke MacGregor

Unleaded petrol in Sydney and Melbourne is headed under $1.00 a litre – and is already there in some cases -- putting more money in consumers' pockets. Fuel bills can represent a major chunk of household expenses, so savings of nearly 30 cents a litre in the last month are significant.

The good news for Australian businesses is that more disposable income usually translates to a pickup in spending. 

The happy central bank

The Reserve Bank of Australia has previously noted that dramatically falling oil prices can represent a similar boost to the economy as a rate cut. Should those low oil prices translate into more spending by consumers, many companies will benefit, with the benefits spreading throughout the economy.

That should trigger higher growth and lead to rising inflation over the long-term, although it may mean lower inflation in the short term.

Foolish takeaway

Simple economics says that at some stage prices should reach an equilibrium level when supply and demand are roughly equal. When we will reach that point is anybody's guess. Demand is growing slower than new supply - which could see lower oil prices for many years.

But the next time you see a scary headline about plunging oil prices, you might want to remember it's not all bad news, particularly the next time you need to fill up your car.

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Mike King is a Motley Fool investment analyst. He owns shares in Flight Centre. You can follow Mike on Twitter here. The Motley Fool's purpose is to educate, amuse and enrich investors. This article contains general investment advice only (under AFSL 400691).

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