Big Drop in Energy Prices May Not Soften Recession

The sharp drop in oil prices won't keep the economy out of a recession, and may not even soften the blow much, analysts say.

Gas Pump
Mark Lennihan
Gas Pump

In normal circumstances, the recent 50 percent plunge in oil prices might give a big boost to consumer spending, which drives three-quarters of the US economy.

But with unemployment rising and the credit crisis still far from over, cheaper gasoline and heating oil probably won't make much difference.

"We have a labor market recession that is deepening, we have tightening credit for consumers and we have asset prices that are falling," Conrad DeQuardos, an economist and founding partner of RDQ Economics told CNBC Friday. "And all that adds up to a weak consumer."

As a result, lower energy prices, while welcomed, will not be a "major driver" in the fourth quarter, DeQuardos said.

Even the September decline in retail sales, reported Thursday, doesn't "capture the full extent of the intensification of the financial crisis," DeQuardos added. "I think it is it going to get worse in the fourth quarter, with substantial declines in consumer spending."

Others are a bit more optimistic about the stimulative effect of lower oil prices, which have fallen from nearly $150 a barrel over the summer to about $73 on Friday.

“It’s the equivalent to a pretty good-sized stimulus package," said Lucian Pugliaresi, president of the Energy Policy Research Foundation. "We are hoping it will take some of the sting out and it should be adding some liquidity into the system as well.”

Of course, much will depend on how low prices go and how long they stay there. Some experts now think that demand for oil will continue to shrink, sending prices to as low as $50 a barrel in the coming months.

“I don’t think we have had a break in consumer energy prices long enough to really have much stimulus effect at all,” adds Timothy Evans, an energy expert at Citi Futures Perspective. “Just for removing a foot from the throat of the consumer, is the consumer supposed to be so grateful that he didn’t actually die?”

OPEC, meanwhile, moved up its next production meeting to Oct. 24 to deal with the sharp decline in crude prices, and Evans said he expected them to announce a one million barrel a day production cut.

OPEC President Chakib Khehil, told reporters Thursday that OPEC would probably cut output to keep prices between $70 and $90 a barrel, which he called “ideal” price range. Oil prices settled below $70 on Thursday, the lowest level in over a year.

OPEC could be constrained, however, by worries about pushing prices up too far.

“If they cut production to stem the oil price slide they risk exacerbating the recession into depression,” says Fadel Gheit, senior oil analyst with Oppenhemier. “They cannot push their luck too much or they will turn the whole world against them.”

The irony is that while lower oil prices are welcomed, they came about largely because the global economy is in such bad shape.

“[This price reduction] would be good if we achieved this via a strong energy policy, conservation, or some sort of dynamic technological breakthrough," says Tom Kloza, chief analyst with Oil Price Information Service. "But we’re achieving this 2008 weight-loss via illness. The economy is quite sick and that’s why demand is down by nearly 10% from the same days in 2007.”

At the same time, the drop in prices isn't expected to derail the recent move toward conservation and alternative energy.

“We are not going to repeal higher [mileage] standards for automobiles," says Evans. "We are not going to rollback biofuel investment, we are not going to see capital expenditures roll back at major oil companies, we are not going to see all of these policy shifts repealed as if $145 [oil] never occurred. We have put things in place that will take a decade or more to run their course. Those economic signals have already been sent.”

In fact, many analysts remain convinced that the age of cheap energy is over.

"The price of oil is likely to rise over the medium to long term,” Nobuo Tanaka, IEA executive director told Dow Jones Thursday. “Even if oil demand were to fall to 60 million barrels daily (from 86 million currently), 60 million is still a very big number. We definitely need more investment by OPEC and other producing countries to satisfy this demand.”

Gheit insisted that market fundamentals do not support long-term oil prices over $60 while Pugliaresi said the $70 to $90 price range was probably "close to the backstop price."