Equity markets have joined crude oil in alarming contraction. Crude prices began their descent in the middle of 2014, flirted with recovery during March-May last year, then foundered, and now sink. Lately testing support at $30/bbl, they have fallen to their lowest level in 12 years and face new pressure as suspension of international sanctions allows Iran to increase exports. Since the start of the crude-price swoon, meanwhile, the stock market has shown more confidence. But a weakening of equity prices since the beginning of this year raises concern about recession in the US and repercussions elsewhere. At this writing, core stock-market indicators had retreated to their levels of a brief slump last summer. Worry is high that the new slump will last longer.
The relationship between crude oil and equity prices is complicated and dynamic. Both asset categories respond to changes in the general economy-crude especially because economic conditions affect demand, and equities especially because of effects on profits. Investors are said to be using the crude price as a bellwether of the global economy. Sometimes traders treat stock prices as signals of crude-price movements.
Problem is supply
What's weakening the crude price, however, isn't demand, which is expanding. What's weakening the crude price is supply, which has been expanding faster than demand. Aggravating the price effects of oversupply are a strengthening dollar and investment flows away from commodities. Anyone using the crude price as an economic gauge needs to account for downward pressures on oil not directly related to consumption. All influences on the oil price-supply, demand, income effects, currency values, commodity-market conditions, geopolitical tensions-interrelate and apply with varying force at different times.
That complexity is being demonstrated now in a way that refutes a political inanity popular whenever oil prices are high. "The oil price works just like a tax," politicians like to say. Actually, no. The governments of most major consuming countries don't set oil prices; they do set taxes. That difference is fundamentally important. And taxes exhibit a much stronger inclination than oil prices do to remain high. That's important, too. If the oil price worked like a tax, why are so many people worried about recession in the US, where oil prices have plunged and product excises aren't high enough to damp the effects? Why hasn't this supposed tax cut done more to stimulate general consumer spending?
As always, other economic factors are at work. Among them are sharp, deep contractions of the oil-producing and oil-services industries, dark reflections of the oil-price slump.
While the upstream oil and gas industry is large, the value oil and gas extraction added to the US economy in 2014 represented only 1.7% of gross domestic product, according to the Bureau of Economic Analysis. That's roughly equivalent to the GDP shares reported for manufacturing of computer and electronic products and of food, beverage, and tobacco products. If share of GDP were the only metric that mattered to the general economy, the boost from falling oil prices would overwhelm contraction of activities accounting for less than 2% of output.
Growth star
In the US economy, though, the upstream industry-largely because of booming shale plays-had been a growth star. Value added in BEA's oil and gas extraction category increased to $302 billion in 2014 from $209 billion in 2010. The industry's share of GDP in 2014, which for most industries doesn't fluctuate much, was more than double what its level had been before steady growth began in 2003. The boom-and-bust nature of oil and gas production, moreover, amplifies effects in other categories, such as construction, as activity surges in areas previously languid-and now, of course, dissipates.
The suggestion has been made that the US economy couldn't have recovered from the 2008-09 recession and continued to expand without the shale booms. Equity markets seem to suggest a test is imminent whether it can stay out of recession without them.
