U.S. Businesses Brace for Oil Downturn

Oil and gas production is fundamental to the U.S. economy. The sharp downturn in prices will have a negative impact on business investment in the short term before the positive impact on consumer spending takes over further down the line.

Oil and gas producers accounted for almost $1 in every $8 of new business investment in the U.S. economy in 2013, according to new data published by the Census Bureau.

Businesses engaged in oil and gas extraction invested $159 billion in wells, structures and equipment in 2013, according to the Annual Capital Expenditures Survey, the latest edition of which was published on Feb. 5 (http://link.reuters.com/dur93w).

Companies engaged in oil and gas production support activities invested a further $20 billion, taking the oil and gas sector's share of economy-wide new investment to almost 13.5 percent.

Back in 2003, oil and gas extraction and support activities accounted for just 5.3 percent of whole-economy business capital expenditures.

Capital investment in oil and gas in 2013 was almost as large as the next three biggest sectors combined: electricity ($86 billion), hospitals ($51 billion) and wired telecoms, broadband and cable suppliers ($49 billion).

The figures for 2014 are likely to have been similar, at least until oil prices plummeted in the second half of the year.

Investment in oil and gas is often under-rated by economists and policymakers because it is associated with climate change and pollution and has none of the favourable connotations of fashionable sectors like clean energy, computers and the film industry.

Oil and gas production is also concentrated in parts of the country like Texas and North Dakota that are a long way geographically and culturally from the universities in California, the Northeast and Chicago where most prominent macroeconomists are employed.

But the oil and gas industry, and its associated supply chain, support an unusually large number of well-paid jobs and the sudden slowdown in spending as a result of the collapse in prices will have a measurable negative effect on the economy.

OUTSIZED CONTRIBUTION

Oil and gas producing industries directly employ fewer than 500,000 individuals out of a total nonfarm workforce of 140 million, less than half of one percent, according to the Bureau of Labor Statistics.

Yet direct investment by the oil and gas industry dwarfed capital expenditures by the more iconic industries beloved by economists and policymakers such as motor manufacturing ($27 billion), aerospace ($7 billion) and computer systems design ($10 billion).

Oil and gas jobs are, moreover, among the best-paid in the economy for highly skilled and semi-skilled workers as well as casual labour.

Average wages in the oil and gas extraction sector, at nearly $160,000 in 2013, were almost three-times the private sector average, according to the Bureau of Economic Analysis. Even in the support sector, average wages and salaries were more than 50 percent higher than average.

EXTENSIVE SUPPLY CHAIN

Raw payroll statistics understate the industry's importance to the whole economy in supporting a multitude of other jobs in sectors ranging from steelmaking (oil country tubular goods) and heavy engineering (rig and pressure pump construction) to transportation (railroads, trucks and aviation) and construction (pipelines and roads).

For example, North Dakota's tiny Sloulin Field International Airport in Williston, right at the heart of the Bakken shale oil play, boarded almost 100,000 passengers in 2013, up from 40,000 in 2012, and just 12,000 in 2008, making it one of the fastest-growing airports in the country.

Sloulin Field, which uses the code ISN for reservations, ticketing and baggage handling, has plans for a big construction upgrade to handle the increased numbers.

The number of passengers boarding each year at all of North Dakota's airports increased by two-thirds between 2008 and 2013, according to Federal Aviation Administration statistics, from under 700,000 to almost 1.2 million, supporting large numbers of jobs for ground staff and flight crews.

On the railroads, surging crude shipments from the Bakken have caused severe congestion for grain and coal shippers along the rail corridor through the northern U.S. states.

In response, Burlington Northern-Santa Fe, Warren Buffett's railroad, which owns most of the track in the area, has announced plans to invest $1.5 billion in its Northern Region in 2015.

A big slice of that investment programme will go to expand capacity in North Dakota and surrounding states by double tracking, installing new sidings and introducing centralised train control, the company said last month ("BNSF's 2015 $6 billion capital plan" Jan 15).

Lots of other industries depend on the oil and gas sector. In 2012, shipments of drill pipe, well casings and other oil country tubular goods (OCTG) from U.S. manufacturers were valued at $6.5 billion, according to an industry assessment filed with the U.S. Department of Commerce.

OCTG producers employed almost 7,500 workers at an average wage of $30 per hour, 20 percent higher than the average for the private sector as a whole.

INVESTMENT SLOWDOWN

With oil prices down by around 50 percent since the middle of 2014, all oil and gas producing companies have announced deep cuts to their capital budgets for 2015.

The number of rigs drilling for oil has fallen by almost 30 percent in less than four months, according to oilfield services company Baker Hughes.

Continental Resources (CLR), one of the biggest drillers in the Bakken, announced late last year it would cut the number of rigs it uses from around 50 at the end of 2014 to 34 by the end of March and to an average of just 31 in 2015.

If these cuts are mirrored across the industry, rig counts and oil field employment could fall by around 35-40 percent in 2015 compared with 2014.

Mass layoffs have already been announced by many exploration and production companies as well as rig contractors and are now rippling all the way through the supply chain, to the makers of drill pipe and suppliers of fracking sand.

Ultimately, lower oil prices should provide a net stimulus for the U.S. economy, since the country remains a net oil importer by around 5 million barrels per day.

Lower oil prices mean cheaper gasoline for consumers, diesel for trucking firms and railroads, and jet fuel for airlines. In time that should encourage increased spending and investment on other items. But the economic benefit from cheaper energy will take time to filter through fully.

In the meantime, the negative impact from an abrupt slowdown in oil and gas investment and employment will be immediate.

"Oil companies are receiving such a painful setback that they are cutting back on current spending immediately as well as reducing future spending plans," according to a thoughtful note published by the famous fund manager Jeremy Grantham.

In contrast, the beneficiaries from lower oil prices may or may not increase their spending on other items, and in any case spending increases may take time ("Jeremy Grantham Divines Oil Industry's Future" Feb 5).

In terms of comparative statics, the U.S. economy will eventually be better off as a result of the plunge in oil and gas prices. But in dynamic terms, the transition from oil and gas-led investment to other forms of consumer spending and investment is likely to be painful.

The same argument can be scaled up to the global level. The oil and gas sector has been one of the biggest investors in the global economy over the last five years and its sudden slowdown is bound to cause a short-term hit even if it has benefits in the long term.

By John Kemp