Gas At $3 Carries Rewards—And Risks

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Gasoline prices have dropped below $3 a gallon at most U.S. gas stations, delivering a welcome lift to American consumers and retailers heading into the holidays. But the related oil-price drop has a thorny underside: It is threatening to slow the nation’s energy boom and hit the broader economy.

The U.S. economy is still set to gain more than it loses from cheaper oil, at least at current prices. Lower prices at the pump give drivers more money to spend on discretionary items like restaurant meals and vacations, and they reduce costs for many businesses.

But the latest drop is spurring debate among economists over how much falling prices will squeeze domestic producers, a reflection of the far-reaching implications from the nation’s energy resurgence.

ENLARGE

Auto group AAA said Monday that 55% of all U.S. gas stations are offering regular grade below $3 a gallon. Here, some evidence of below-$3 gas on the marquee at a gas station in Mill Valley, Calif. Getty Images

High oil prices in recent years drove the energy boom by making costly drilling techniques like hydraulic fracturing economically feasible. Now, oil-rich states could see job growth slow. Producers would see profits tumble. And investors are already retrenching from one of the hottest sectors of the expansion.

“It creates winners and losers,” said David Rosenberg, chief economist at money-management firm Gluskin Sheff & Associates. “But with or without a shale-gas revolution, the U.S. economy comes out a winner.”

The national average for regular gasoline fell to a four-year low of $3.04 a gallon on Monday, according to auto club AAA, with 55% of stations selling gas below $3 a gallon. Gas prices were as high as $3.68 at the end of June, sitting above $3 a gallon since December 2010.

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And oil prices, which have fallen 25% since mid-June, tumbled below $80 a barrel on Monday—before recovering to close only slightly lower at $81 on the New York Mercantile Exchange—after Goldman Sachs cut its oil forecasts for the first quarter of 2015 to $75 a barrel for the U.S. benchmark. Prices climbed as high as $107.26 a barrel as recently as June when tumult in the Middle East rattled markets about potential supply disruptions.

The decline in prices follows “the longest period of high oil prices in the history of the United States,” said James Williams, an energy economist in London, Ark.

Those higher prices unleashed a surge in domestic crude-oil production, which has climbed more than 50% since 2010, according to government figures. The oil and gas extraction industry accounts for 1.7% of U.S. gross domestic product, which is one-half percentage point higher than its average since 1976, according to J.P. Morgan economists.

“Unless the prices reverse, we’re going to see a substantial impact on what has been the hottest growth sector in the last four years,” Mr. Williams said.

 

As long as oil prices remain at or above $80 a barrel, production is profitable for all but 4% of U.S. wells, according to the International Energy Agency. Analysts generally agree that production would slow only if prices fell below $75 a barrel.

“Right now, it’s full steam ahead,” said Martin Craighead, chief executive of Baker Hughes Inc., an oil-field-services company, in an earnings call earlier this month. “If we are sitting at $75 come the holiday season…then certainly I think the conversations with the customers will be different.”

Investors could also rethink their appetite for bonds issued by drilling and oil-production firms. “There was too much investment that assumed prices would never go down,” said Philip Verleger, an energy economist in Carbondale, Colo.

ENLARGE

 

One looming question is what lower prices mean for Texas, Oklahoma and North Dakota, where the energy boom allowed for a milder downturn—the housing bubble largely bypassed the region—and a much stronger recovery. North Dakota, home to the oil-rich Bakken Shale, had the fastest-growing state economy last year, expanding 9.7% from 2012. It also had the lowest unemployment rate, at 2.8% last month.

“If the wheels come off, the energy-producing economies are going to suffer,” said Ken Medlock, a senior director at Rice University’s Center for Energy Studies.

That could have ripple effects on housing and jobs. While the oil and gas industry has added only about 60,000 jobs since 2010, a fraction of the nine million jobs added in the entire economy, it has been a source of high-paying employment. But other sectors also benefit, boosting broader job creation in a region.

When businesses need to get a handle on costs, “one of the things you stop doing is paying welders $100,000 a year,” Mr. Verleger said.

In Midland, Texas, developers scrapped plans last month to build a 53-story tower downtown after signing a purchase deal with the major oil town for the land in March 2013.

Firms like Ford Steel, a maker of drilling parts for the oil industry in Porter, Texas, are also anxiously watching prices. The company, which employs 75, added 15 new positions this summer, but plans to add a second shift early next year are now on hold. “We’re going to hold off on that until we figure out what’s going to happen” to customer demand, said Katherine Jeffries, a management representative.

Meanwhile, transportation companies, farmers and manufacturers enjoy better profit margins as their costs fall. Fuel price reductions are “a huge opportunity going forward,” Delta Air Lines Inc. Chief Executive Richard Anderson told investors earlier this month. The drop in prices has resulted in $1 billion in lower costs for the airline over the past few weeks, he said.

Of course, the biggest beneficiaries of lower prices are American consumers. A rule of thumb holds that every one-cent drop in energy prices is worth $1 billion in annual household consumption nationwide.

Middle-class families could feel considerable breathing room from lower prices. In 2012, families with income below $50,000 spent an average of 21.4% of their income on energy, nearly double the share in 2001, according to economists at Bank of America Merrill Lynch.

“There has never been a time, nor will there be a time, where a drop in energy prices doesn’t add spending power to the consumer,” said Gluskin Sheff’s Mr. Rosenberg.

Take Cindy Matson, who lost her job last year and was hesitant to accept her current job, at an industrial battery maker, because it requires a 45-minute commute each way from her home in New Florence, Pa.

With gas prices heading near $4 a gallon, “it took me a while to figure out if I wanted to spend that much traveling,” said the 50-year-old Ms. Matson. “Lower gas prices make it a little bit easier for us.”

Still, the benefit from lower oil prices could take longer to materialize because of improved fuel efficiency, which has made consumers less sensitive to price swings. For model year 2014, vehicles are projected to have average mileage of 24.2 miles a gallon, up 7% from 2010 and 25% from a decade earlier.

Moreover, for the economy to benefit in the short run, it needs to see Ms. Matson spend her savings. Instead, she wants to shore up her retirement funds. “Anything extra, that’s what I’ve been doing with it,” she said.

Write to Nick Timiraos at [email protected]

Corrections & Amplifications

Oil prices climbed as high as $107.26 a barrel in June. An earlier version of this article prices incorrectly said the high was $103.66 in June.