In mid-2014, crude oil prices were about $100, depending on which grade you wanted to buy. Now prices hover near $30—roughly a 70% decline in 18 months.
That’s well-known, but we usually discuss the price collapse in terms of particular countries or companies: we don’t look at the bigger picture.
Last week someone showed me this from Twitter. I almost fell out of my chair.
Stop for a minute. Let that sink in. The total value of all the world’s oil reserves is over $100 trillion less than it was just a year and a half ago.
To put these figures in perspective, consider that Google’s parent company, Alphabet, briefly surpassed Apple last week as the planet’s largest publicly traded company.
Both are worth around $500 billion, depending on the day. The lost value in crude oil is equivalent to a couple of hundred Googles and Apples going up in smoke.
If stock values were crashing to that degree, we would call the losses earth-shattering. Yet otherwise intelligent people are saying the oil collapse is a minor issue.
It is true that the loss of value is somewhat less dire than the raw numbers imply. The companies and countries that own the world’s oil reserves don’t usually value them at the market price.
They mark the value up or down gradually, using long-term average prices or other discount mechanisms. They also account for production costs.
Nevertheless, if your wealth is tied up in oil reserves, your asset valuation is down sharply since a couple of years ago. The collective balance-sheet hit adds up to a staggering amount of money.
It Will Affect Everyone
Set aside the accounting considerations for a moment, though. Economists talk about the “wealth effect” that occurs when asset values go up.
If your stocks, real estate, or other assets gain in value, you derive no immediate benefit unless you sell them. Yet you feel wealthier and more confident.
That confidence changes your behavior, so you spend more freely. You’ll buy that second home, nicer car, or diamond ring. You’ll take more risks with your investments.
The wealth effect is a real phenomenon, and it has economic consequences. In a consumer-driven economy like the United States, higher spending from asset-wealthy people lets businesses expand and create jobs.
Politicians and Fed officials tout the effect as a beneficial consequence of their genius plans. Yet they seldom remind us of the negative wealth effect that occurs when asset values decline.
When your perceived wealth contracts, however, you cut spending and turn cautious. Your altered strategy also has macroeconomic consequences—but sometimes they aren’t immediately obvious.
Why the 2009 Recession Boosted Lawn Mower Sales
I recall reading back during the 2009 recession that lawn mower sales had spiked higher.
That seemed odd at first, but then I understood: affluent people, who had lost jobs or income, fired their yard services and started mowing their own grass. A good move for them, but terrible for yard workers.
So, whatever the audited financial statements reflect, it’s safe to say that the owners of those 1.656 trillion barrels of oil are feeling much less wealthy now.
Their paper losses are affecting their behavior as surely as falling US home prices affected consumer behavior in the last recession.
It isn’t just oil, either; other commodity prices have also collapsed. All the industrial metals—copper, zinc, nickel, lead, palladium, platinum, silver, and aluminum—suffered double-digit percentage losses in 2015. Ditto for coal, natural gas, and iron ore.
Right now, owners of all these resources are experiencing a severely negative wealth effect. They are changing their behavior, and the resulting trends are not good for you if your own wealth depends on their continued spending and investing.
We can’t put an exact number on this perceived wealth loss, but it is certainly in the tens of trillions of dollars—equivalent to a massive, worldwide bear market in stocks. Yet it is happening beneath the radar, almost unnoticed and unremarked.
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While everything is true, what it misses, is the derived wealth that others will realize. Let us say a bushel of grain is $5, and it dropped to $4 because of oil collapse, now that farmer will trade 7.5 Bushels for 1 barrel equivalent vs before trading 20 bushels for 1 barrel, thus realizing a 266 percent increase in his wealth. Many synthetics, dyes, and medicines require oil as seed stock, these are now less expensive even if the companies do not pass on the savings. So the world is much more complicated than the one dimensional version given above.
