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The Recession Caused By Low Oil Prices

Donald L. Luskin, The Wall Street Journal

Misery for oil incumbents from the fracking boom is spilling into the global economy. But there is cause for optimism.

The global economy is slipping into recession. The evidence is showing up in all the usual ways: slowing output growth, slumping purchasing-manager indexes, widening credit spreads, declining corporate earnings, falling inflation expectations, receding capital investment and rising inventories. But this is a most unusual recession—the first one ever caused by falling oil prices.

We’ve had plenty of recessions caused by rising oil prices: 1973-75, 1980-81, and 1990-91. In these recessions, the oil price ultimately fell as demand collapsed.

But this time oil prices have fallen more than 70% since mid-2014, while demand has been rising. The drop is entirely the result of America’s supply-side technology breakthrough with horizontal drilling and hydraulic fracturing—“fracking.” This has given consumers world-wide what amounts to a tax cut of $7.8 billion every day, or about $2.9 trillion over a full year.

So shouldn’t there be an economic boom, rather than a bust? Yes, eventually. But first, because of its magnitude and speed, the technology revolution that drove down oil prices has also threatened the important institutions that benefited from high prices. Collectively, these institutions are down $2.9 trillion.

For a century and a half, the largest global corporations and cartels of oil-producing nations have controlled the oil market. The years of “secular stagnation” after the Great Recession were mostly good times for them, with fears of “peak oil” making inflation-adjusted prices the highest in history.

Now thanks to the U.S.-led revolution in fracking, oil is abundant. It will be for decades, if not centuries, because there is shale everywhere in the world. And unlike the megaprojects that have dominated the oil industry over the past several decades, shale can be tapped by smaller companies with less capital. The oil market, as OPEC has learned to its sorrow, is now much more difficult to control.

This is capitalist creative destruction. But nowadays it happens on Internet-time, so it’s also “disruptive innovation.” Fracking is to the global oil industry what Uber is to taxi medallion owners: great for consumers who enjoy the sudden abundance, deadly for incumbents whose business models were built on exploiting scarcity. […]

There has never been a recession caused by low oil prices, so there is no playbook for how this one might evolve. It is critically dependent on how the global consumer responds. If the rigors of recession reduce demand for oil—as happens in a typical recession—then we’d have a vicious cycle in which further oil price declines would make the recession worse.

But there is also cause for optimism. Low oil prices make the global consumer very resilient, which buffers the recession’s severity and duration. The best news is that, thanks to fracking, recessions caused by high oil prices are a thing of the past.

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