Matt Winkler: Why the U.S. Gets the Most Out of Cheap Oil

Originally posted on Bloomberg View.

Cheap oil should be good economic medicine for almost anybody who isn't trying to sell the stuff. Yet only one country has been able to take full advantage of the 14-month collapse in the price of crude: the U.S.

A big part of the reason was the success of the Federal Reserve at repairing the country's credit after the financial crisis. That let corporations reduce their debt to the lowest levels in decades while the unemployment rate fell to 5.3 percent from 10 percent. Consequently, American producers and consumers were in a strong position to enjoy the fruits of their labors with oil in retreat.
 

The rest of the world keeps struggling to make the most of cheap oil. Industrial production in Japan, the third-largest economy, is down about 15 percent from its 2008 peak. Germany, the fourth-biggest, is growing at only 1.7 percent a year, while the countries that make up the euro zone share an unemployment rate of 11 percent.

China's composite Purchasing Managers Index, which measures the health of manufacturers, has declined to a new low, buffeted by slowing growth and waning investor confidence. Brazil is contracting from depressed commodity prices, diminished trade with China and a widening government corruption scandal.

In the U.S., by contrast, producers and consumers are in harmony. Companies in the Standard & Poor's 500 Index have the lowest net debt-to-earnings ratio in at least 25 years, along with $3.52 trillion in cash and marketable securities and record earnings per share, according to data compiled by Bloomberg. For these companies, the ratio of net debt to Ebitda, or earnings before interest, taxes, depreciation and amortization, is 1.7, down from a high of 4.9 in 2003 and near a 25-year low.

The American economy is seeing the fastest average monthly job creation since 1999. As more Americans join the job market, they have more money to spend as manufacturing efficiency improves. That probably explains why Detroit's three automakers reported surprisingly robust sales in August. General Motors says that total industry sales this year will climb to 17.3 million, the most since 2006.

U.S. companies became more profitable and consumer demand surged as oil was collapsing to a low of $37.32 a barrel on Aug. 24 from $104.67 in June of 2014. That's reflected in the healthy gross margins of the 500 companies in the S&P, which edged up to 33 percent this year from 32 percent in the second quarter of 2014. 

Lower costs of raw materials and energy needed to run a factory are giving U.S. companies the ability to produce more of what they make at lower cost. Meanwhile, their customers had extra cash to spend. This lets Americans drive up sales of consumer companies like Whirlpool, CarMax and Chipotle Mexican Grill. Sales per share of the 85 companies in the S&P's Consumer Discretionary Index are at their highest valuation since Bloomberg began compiling the data in 1990. 

Among the nine relevant industry groups in the S&P 500 (excluding the financial industry, which doesn't show the gross margin measure), five experienced rising profitability as oil declined.

INDUSTRIES WITH RISING PROFITABILITY

There are dozens of examples of companies with much improved profit since oil started losing so much of its value. The gross margin for General Motors increased to 14.6 percent from 9.6 percent during the past 12 months. For Goodyear Tire & Rubber, the No. 3 global tire maker, it climbed to 27.4 percent from 24.1 percent. Alcoa, the largest U.S. producer of aluminum, saw its gross margin expand to 15.5 percent from 12.4 percent.

The last time companies showed such a marked improvement in profitability was in the immediate aftermath of the financial crisis at the end of 2008, when oil fetched $40 a barrel, comparable to its price today.

Futures traders anticipate oil rising to $62 a barrel by June 2023. That's still less than $64 price they speculated it would be a month ago and well below the $94 for 2019 they were predicting five years ago, Bloomberg data shows. 

If these expectations hold up, the period that correlates most with the present is the 1990s, when oil hovered at $20 a barrel. Then as now, cheap oil boosted the price of the dollar, which rose 46 percent between 1995 and 2001 as American companies became increasingly profitable. Even today's strong dollar remains 17 percent below its 2001 peak, and rising gross margins help lighten the impact of the stronger currency. Once again, the U.S. economy gets better in an era of cheap oil.

(With assistance from Shin Pei)

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the editor responsible for this story:
Jonathan I Landman at jlandman4@bloomberg.net