Oil Economics and The Auto Industry
“Drill, baby, drill!” has finally worked, but only because OPEC cooperated, at least temporarily. Until recently, increased U.S. production has failed to result in low fuel prices at the pump. There is no good reason for global oil market prices to have stayed so high for so long in the face of dramatically increased U.S. production unless OPEC had curtailed its own production to provide price/supply equilibrium. That has been OPEC’s modus operandi for decades. Though OPEC started off with five members and now has 12, it has yet to produce any more oil now than it did in 1973. Since then, the global population has doubled, and oil consumption has almost tripled. It’s not because OPEC couldn’t or can’t produce more; it’s because OPEC operates like a cartel.
The recent decision to continue production at current levels prompted a steep drop in oil prices. Fuel prices at the pump have taken a dive, to the delight of consumers. EVs and hybrid sales have slowed dramatically, and the alternative fuels and high-cost oil producers are shaking in their boots. So how will the recent OPEC decision to continue production at current levels impact the auto industry? It is clear that with cheap fuel at the pump, the sales of small, fuel-efficient vehicles will have to be steeply incentivized, or many OEMs will pay huge fines to comply with Corporate Average Fuel Economy (CAFE) regulations. That won’t help residual values on pre-owned vehicles, as Rene Abdallah, vice president of residual value insurer RVI Group, has been saying for years. Fortunately for lenders and captives engaged in leasing, there aren’t too many smaller vehicles in lease service. On the other hand, sales of “heavies” — like SUVs and pickups — will boom, providing strong residuals and short-term auto industry profits. Sales of those vehicles will also set us up for the next spike in fuel prices — you know, the type of spike that kills residual values of heavies, stops sales of new heavies, and triggers recessions.
Who knows how long our economy will enjoy these fuel prices? What else could happen? The low fuel prices will help keep a lid on inflation, even though auto fuel isn’t technically a part of the Consumer Price Index. Will the Federal Reserve take advantage and raise interest rates, feeling there is less risk in doing so? This is a mixed bag, and it is hard to know which element will carry the most weight. A rise in mortgage loan interest rates and auto loans would most certainly result in some consequences. Will those consequences be enough to slow the economic growth spurred by lower fuel costs, or will the momentum created by the low fuel prices overwhelm the other issues? That’s for the economists to calculate through their mathematical models.
The Obama Administration and the “Green Movement” are disappointed that interest and investment in alternative energy and sales of fuel-efficient vehicles will slow. On the other hand, the administration can’t help but be leased that the sanctions on Russia over its incursion into Ukraine carry extra weight now. There is also rampant speculation that Iran and Venezuela are displeased with this decision crammed down their throats by U.S. ally Saudi Arabia. The House of Saud, Sunni Muslim Arabs that they are, aren’t particularly pleased to see any extra petro dollars go to Shiite Muslim Persians to develop a nuclear program and spread terrorism, through Hezbollah and other terrorist groups, around the Middle East. Many think the Saudis took advantage of the situation to do what they wanted to do along, which is to manipulate the global market price of oil to a level to force many competitors out of business so they can raise the price with impunity down the road. After all, they’re in it for the long-term dollars, not the volume. Iran and Venezuela are thinking short term. They can’t sell any more oil under the OPEC pact, but they receive substantially fewer dollars. Who do the Saudis see as competitors? Answer: Oil sand and shale producers, frackers, alternative fuel producers, and the EV industry. There are rumors of more than 3,000 unsold Tesla Model S cars parked in some secret location. For a while, U.S. consumers will be thrilled. The moderate oil prices may help the world’s largest economy, the EU, avoid a second recession, which is also good for us. But there is another shoe to drop. We just don’t know when. We should enjoy it while we can.
David Ruggles has spent his career in every phase of the retail side of the auto business, new and used, sales and management, including consulting and training in both the U.S. & Japan. Ruggles has been a dealer for Mercedes-Benz, Chrysler, Dodge, GMC, Ford, Mazda, and Subaru, and has consulted for one of the world’s largest privately owned Toyota dealer groups located in Japan. He blogs at autosandeconomics.blogspot.com and writes regular columns for several publications.
