Back when I was in lower school, I remember riding with my dad almost every weekend in his Chevy Suburban to go find gas. We would drive down Peachtree Industrial Blvd in Atlanta — where there were about a dozen gas stations within a couple mile stretch — to find the lowest price. The cheapest gas price I ever saw on our weekend trips was $1.16, and to this day I still haven’t seen it any lower.
But with the price of crude oil at its lowest mark since 2003, I might soon see a gallon of gas below $1.16. While low prices at the pump have great immediate effects for consumers, they can have potentially dangerous effects on the economy as a whole. At SMU, a school whose financial fortunes have risen over the last decade thanks in large part to the U.S. shale revolution, students should be concerned about these deflated prices.
To understand the dangers of low oil prices, we first have to look at how those prices fell so far. The U.S. shale revolution caused an unprecedented spike in domestic oil production and, coupled with high crude prices, created a perfect environment for the U.S. energy industry to flourish. High domestic production meant that the U.S. was taking away market share from the Organization of Petroleum Exporting Countries (OPEC), which accounts for about 40 percent of the world’s crude output. In late 2014, OPEC decided to increase production in order to defend its market share. Prices fell sharply from above $100 to the current price of below $30. At these prices, almost no wells in the U.S. are profitable to drill. We’ve already seen tens of thousands of layoffs in Texas, where millions of its residents are employed by the energy industry.
Much of SMU’s financial success in the past decade can be attributed to the strength of the Texas economy, which has been fueled by the energy industry. SMU officials have noted that the university’s endowment is more heavily concentrated in oil and gas investments than the endowments at most other universities. In the past year, publicly traded energy companies have lost half their market value. If SMU’s endowment were to decline in value, then administration would be forced to make budget cuts. (I’ll go into more detail about this possibility in my next column.)
With several construction projects making it harder for students to walk across campus, it may seem like the oil drop is having no impact on SMU. But there is a lag between when oil prices fall and when energy companies start running into problems. Most companies have been able to survive up to this point, but will start running into major problems in the near future.
When prices began to fall, most oil companies had hedges in place that allowed them to lock in prices 12 to 18 months in advance. Even as their hedges roll off, these companies have been able to borrow money by issuing bonds to weather the downturn. But now that some companies have run out of borrowed money, the last hope before bankruptcy is private equity funding. These funds see low oil prices as an opportunity to make attractive investments. But if prices do stay lower for longer, many oil companies in the U.S. will cease to exist.
We’re creeping closer to this scenario becoming a reality.
Most investment banks have a less than positive outlook on the future of the energy industry. Investment research from Goldman Sachs uses the theme “Lower for Longer” to describe the state of the oil industry. According to the research, the U.S. shale revolution has created a new landscape in the energy industry that will cause a “new era of volatility” and will “trigger a supply correction toward a new equilibrium.” In other words, the energy industry must learn to cope with low prices for many years to come.
With the energy industry in turmoil, SMU faces potential risk in its largest donors, many of whom amassed their fortunes from producing oil, and who might slow down their giving.
But, SMU may be able to lean on the strength of the Dallas economy to cope with the fall in oil prices. According to Dr. Bud Weinstein, an economist and professor at SMU’s Cox School of Business, Dallas’ economy is relatively diversified economy relative to Texas as a whole, allowing it to “weather the storm” of low oil prices. Weinstein believes the Dallas economy can continue its steady growth, and that Dallas can remain insulated from the shock of the oil decline. If Dallas continues to grow in this environment, then SMU can leverage the local economy continue to expand its campus, construct new buildings, and grow as a national university.