Back in late 2014, when oil prices tumbled after the OPEC “thanksgiving massacre“, the conventional narrative was that dropping oil prices were a boon for the economy as they resulted in lower gas prices and thus greater discretionary income. The stark reality emerged quickly, however, once US corporations halted capex spending, resulting in a mini-recession for business investment coupled with dozens of shale bankruptcies.
Fast forward 4 years when Brent oil prices are trading back near $85/barrel, their highest level since October 2014, right before they tumbled. And with the “lower oil is beneficial for GDP” narrative discredited, following the recent rally, questions about the economic impact of oil prices have resurfaced, among them: have higher oil prices contributed to the upside surprises to 2018 growth via higher energy capex, as Chairman Powell suggested last week? Can US shale further ramp up production when capacity constraints are looming? Do higher energy prices still exert a meaningful drag on consumer spending and boost core inflation in an era of increased energy efficiency?
This is an analysis that Goldman conducted this week, and found that higher oil prices have had a neutral impact on GDP growth so far this year with a -0.25pp contribution from lower real consumption roughly offset by a +0.25pp contribution from higher energy capital spending. However, if oil prices remain at their current level the net growth contribution will decline to -0.1pp to -0.2pp in 2018Q4 and 2019H1.
The key reason is that while higher oil prices will remain a steady drag on consumption growth, the boost to energy capex is likely to shrink as the shale industry runs into transportation capacity constraints. It is only in 2019 H2 that the eventual arrival of new pipelines will likely trigger a re-acceleration of energy capital spending.
Stepping back for a look at the big picture, Goldman adds up the consumer spending and energy capex channels, with the estimated net effects of energy price moves on GDP growth shown in the chart below.
Overall, Goldman expects that oil prices will turn from a roughly neutral factor for GDP growth year-to-date into a 0.1-0.2pp headwind in Q4 and 2019H2, as the 0.25pp drag from lower consumer spending will soon outweigh a shrinking 0.1pp contribution from energy capex.
And, as noted above, it is only in 2019H2 that oil is likely to turn roughly neutral as capacity constraints ease and the drag on consumer spending dwindles. Importantly, the binding constraint of a lack of transportation solutions leaves the risks to this growth impulse as skewed to the downside if prices rally further, given the lopsided negative impact on consumption in coming quarters.
What about the impact of oil prices on US inflation?
Goldman finds that in addition to substantially lifting headline inflation, the recent rise is likely also contributing to the rise in core inflation. It then estimates the energy contribution to year-over-year core PCE inflation will peak at 0.15% around the turn of the year before edging lower to 0.1pp by end-2019. The peak core inflation boost from energy prices is therefore likely to occur around the time Goldman expects to see a meaningful boost from additional tariffs on imports from China.
In summary, Goldman expects higher oil prices to contribute to its forecasts of moderating GDP growth and gradually rising core inflation over the next several quarters.
The negative growth effects and positive inflation effects from higher oil prices bring us back, at least directionally, to the pre-shale era where oil shocks were often followed by sharp growth slowdowns or even recessions.
However, the bank does not see the recent rally as a major threat to its outlook for still “solid growth” in 2019 because consumers are now less vulnerable to rising energy bills than in prior cycles (the energy share in personal consumption has fallen from 10% in the early 80s to 4% today) and because the lifting of capacity constraints should bring the capex boost from shale back to life in H2.
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