Last week was momentous for the U.S. economy and the domestic oil and gas business due to actions in Washington, D.C. First, the Federal Reserve agreed to hike the federal funds rate by 0.25%, the first such increase in seven years. The second event saw Congress approve legislation ending a 40-year ban on the export of U.S. crude oil.
The interest rate hike reflected our monetary authorities’ belief that the U.S. economy, especially the nation’s labor market, is now healthy enough to absorb higher interest costs as we transition back to a more normal interest rate environment. While a quarter of a percentage point increase from essentially zero is not an earth-shattering move, it will mean slightly higher costs for consumers with credit card debt and variable-interest rate loans such as for mortgages and home equity lines of credit.
Initially, the interest rate move was greeted positively by the stock market, as it rallied strongly the day of the announcement. However, the stock market promptly dropped nearly 600 points the following two days as investors assessed the impact of cost increases for U.S. businesses and their customers. The interest rate hike, which was expected to lift the value of the U.S. dollar, caused commodity prices to drop significantly late last week. The price drop suggested that the interest rate hike will reduce global economic growth and thereby lower demand for commodities, one of which is crude oil. In fact, on the NYMEX exchange, the price of WTI fell by 7% between last Tuesday’s close, the day before the Fed’s announcement, and Friday. WTI’s price continued to fall Monday morning, trading around $34 a barrel, nearly matching the seven-year low established in 2008.
The big question for 2016 may be whether the value of the U.S. dollar rises – as expected by economic theory and most monetary economists – or falls. Recent research by several Wall Street investment strategists looking at the last five interest rate hikes shows that in the first six months following the initial hike, the value of the dollar actually fell. If that happens a sixth time, a weaker U.S. dollar would become supportive of higher crude oil prices, replacing the headwinds that have hampered higher oil prices over the past year.
Falling U.S. oil output, stronger global oil demand and a weaker U.S. dollar might result in improved crude oil prices next year, which would help the domestic oil and oilfield service industries.
The end of the oil export ban is being heralded as a positive for the profitability of the domestic oil business as WTI trades at a roughly $2 a barrel discount to Brent, the international oil marker. As long as the cost to move U.S. oil to foreign markets does not exceed the Brent-WTI price spread, U.S. producers would earn more money selling their product abroad. It is hard to know whether the current price spread is sufficient to boost U.S. oil exports, but over time it probably will, thus becoming an incremental profit driver for domestic oil companies.
Although the stock market’s assessment of last week’s events was negative, the potential decline in the value of the U.S. dollar due to rising U.S. interest rates coupled with lifting the oil export ban could aid an oil price recovery next year.
