Lower Oil Prices Means Fewer Jobs :: Wamhoff Financial & Accounting

Lower Oil Prices Means Fewer Jobs

In the not-so-distant past, Americans were inundated by the mainstream media and the political class regarding the importance of U.S. energy independence. As the shale boom began in earnest, the job creation and domestic oil production increases were supposed to be a huge win for the country and for consumers.

According to Asjylyn Loder of Bloomberg, “The U.S. shale boom that’s brought the country closer to energy self-sufficiency than at any time since the 1980’s will be challenged in 2015 as never before.” Based on historical oil futures prices from investing.com, the recent high in oil futures occurred on June 25, 2014 at around $107.50 per barrel with the lowest oil futures price occurring on January 26, 2015 at $44.35 per barrel. The price action in oil futures from the June 2014 high to the January 2015 low represents a price decline of nearly 58.75%. The price chart of oil can be seen below.


As can be seen above, the decline in West Texas Intermediate crude oil is extreme since June of 2014. The rapid decline in the price of oil has helped to reduce gasoline prices at the pump for U.S. consumers. The chart of gasoline prices is shown below:


Lower gasoline prices are helping consumers save money at the pump and allow discretionary dollars to be spent on other items. Lower oil and gasoline prices would appear to help the U.S. economy continue to recover from the Great Recession, but the real data may paint a different picture. A deeper dive into the oil marketplace is crucial in understanding what the future may look like regarding oil and gasoline prices.

Right now oil prices are continuing to trend lower, which is starting to impact production. The first negative impact of the price decline are energy related jobs. When focusing specifically on states that have the largest exposure to oil related industry, we can see a dramatic shift in jobless claims in states such as Texas, Colorado, North Dakota, Pennsylvania, and West Virginia.

Chart Courtesy of www.zerohedge.com & Bloomberg

As can be seen above, when comparing the jobless claims in states with significant exposure to energy extraction a trend can clearly be seen. As the price of oil (blue) moves lower, the jobless claims (red) in the major oil producing states spikes higher.

While the average American is enjoying lower prices at the pump, individuals who earn a paycheck in the oil fields or from oil related industries are seeing massive layoffs and job cuts. While the overall economy may enjoy lower oil prices, there is still an economic loss as a result of the job cuts and the negative impact on wages. Clearly if oil prices remain depressed, the economic toll in the states discussed above will become more severe and regional recessions could potentially occur.

The easiest way to visualize what is driving the reduction in oil related jobs is to view a critically important aspect of the energy marketplace, the proverbial “rig count”. The rig count is the total number of energy rigs in operation in the United States. As can be seen below, the total U.S. rig count is declining along with the price of oil futures.

Chart Courtesy of www.zerohedge.com & Bloomberg

When viewing the chart above, looking specifically at the 2007 – 2009 time frame demonstrates the relationship between the rig count and the price of oil futures. As can be seen during that time frame, the rig count lags the oil price and we are seeing that again in the present time frame. As drilling rigs are taken offline, jobs associated with the operations are eliminated. If history is a guide, this chart is indicative that future job losses in the oil patch are likely when looking at the total rig count.

Logically the next question that comes to mind is what is actually driving the rig count reduction? Clearly the price of oil going lower is to blame, but why is the rig count reduction moving lower so violently? The answers to those questions are based around the fundamentals regarding shale oil production.

The first key element to understand is that the oil output of shale developments decline rapidly after they are initially drilled. The Economist article “In a Bind” shares the following quotation, “the output of shale wells declines rapidly, by 60% – 70% in their first year, so within a couple of years this oil will stop flowing.” Furthermore, Wood Mackenzie, a research consultancy firm, estimates that the break-even price of American shale projects is around $65 – $70 per barrel. [The Economist]

According to Wood McKenzie, “If the oil price stays at $70, it estimates investment will be cut by 20% and production growth for America could slow to 10% a year. At $60, investment could drop by as much as half and production growth grind to a halt.” [The Economist] In addition to a reduction in rig count, it is anticipated that if prices remain depressed new investment is likely to decline considerably. This places a further drag on employment gains in oil related industries.

The reason energy companies are reducing their capital expenditures for future projects and taking existing oil wells offline, is related to breakeven prices in the various oil formations. The chart below illustrates the breakeven oil prices for the various oil fields in the United States and Canada.


As can be seen above, the breakeven oil prices vary by oil field. According to Investing.com’s oil futures price history, the closing price on January 27, 2015 was $46.23 per barrel of oil. Every oil field shown in the chart above is underwater based on their individual estimated breakeven price point besides the Montney Oil Formation.

The oil formations that have estimated breakeven oil prices above the current price are clearly going to reduce their oil production to the best of their ability. Furthermore, it would also prove that it would not make economic sense to begin adding additional oil production in fields where the price is well below the estimated breakeven oil price.

Ultimately, it goes without saying that while the average U.S. consumer is enjoying lower gasoline prices at the pump, the economies of states who are reliant on the energy industry for job creation and wages are going to be hurt economically. The data is already indicative that rig counts are dropping and will likely continue to move lower as oil prices remain depressed. Furthermore, this places a drag on energy related job hiring and increases overall jobless numbers nationwide.

Whether or not the lower oil prices are great for the overall U.S. economy is unknown. However, what is known is that if oil prices remain depressed or continue moving lower, future capital expenditures for growth in the oil sector may come under pressure. This would potentially lead to more job losses and potential fiscal strains for states that rely heavily on the energy industry for tax revenues.

In closing, the next blog will remain focused on oil prices and will discuss the impact that lower prices are having on nations that are totally reliant on energy production to manage their national budgets. Additionally, I will dig deeper into the shale oil business and the fundamentals involved in shale energy production. Until then, Happy Investing!