May 11, 2020 - Economy

How oil's collapse will weigh on the U.S. economy

Data: FactSet; Chart: Axios Visuals
Data: FactSet; Chart: Axios Visuals

Investors have abandoned oil at warp speed so far this year as futures prices have fallen to record lows. Even as oil has bounced from its record trough in April, investors remain skeptical about the chances for sustained value appreciation.

Why it matters: "Typically, oil price fluctuations have a small aggregate impact on US growth, with roughly offsetting effects from the energy capex and consumption channels," Paul Choi, biotechnology analyst at Goldman Sachs, writes in a note to clients.

  • "However, the sharp rise in the likelihood of bankruptcies in the energy sector and spending constraints due to the virus suggest that the decline in oil prices might be a larger drag on growth this time."

The big picture: The U.S. is now the world's No.1 oil producer, which means more of the economy is dependent on oil and gas production.

What happened: Energy saw the biggest change in positioning of all market sectors, as traders sold nearly 80 million shares of energy stocks during the first quarter, Bank of America Global Research notes. That put energy's relative weight in overall fund holdings at its second-lowest level in the bank's data history, dating back to 2008.

  • Hedge funds sold oil at an even more extreme pace and held record underweights at the end of the first quarter.

What to watch: Oil's historically low prices mean that more bankruptcies are "likely unavoidable," Choi says. Goldman's estimates currently imply "a 50-60% year-on-year decline in energy capex in Q2/Q3, similar to the decline in 2015/2016."

  • In addition to the increased bankruptcies, that will likely also mean more debt and less investment for the companies that are able to survive, meaning sustained fundamental weakness in the sector.

The last word: Analysts expect oil will provide a net drag on overall U.S. GDP growth of roughly 0.25 percentage points, year over year, Choi says.

  • "While this would normally represent a meaningful drag on growth, in the current environment oil is unlikely to be a major factor for overall growth."

Go deeper: A world locked down and drowning in oil

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