Decline in energy prices doesn't translate into consumer spending

While households have benefited greatly from lower energy costs, not a whole lot of that extra cash has flowed into consumer spending. Meanwhile, energy companies have cut back sharply on their spending, slowing economic growth.

So is a decline in energy prices bad for the economy? Maybe in the short run, but only if the price drop is huge.

Over the last year, the price of oil has been cut in half. Not surprisingly, the price of gasoline followed down the cost of oil, though the 25 percent drop was not nearly as great. Regardless, what matters most is that the lower cost of energy has translated into rising spendable income for households.

For every penny decline in the price of gasoline, between $1 billion and $1.25 billion is left in U.S. household wallets rather than being pumped into gasoline tanks and burned. With gasoline prices down about 85 cents since July 2014, consumers have sliced almost $100 billion off their fill-up costs.

Given all that newfound wealth, families should have splurged. Well, maybe just a pizza each week. But that hasn't happened. Retail sales are up only about 2 percent this year compared with the first half of 2014. That's hardly an indication of consumers gone wild.

There's a very good reason we haven't seen a shopping binge. Those who absolutely need to spend the energy savings have done so. But for the rest, the extra money comes only when they fill up, meaning it takes time to build in the bank account.

When the energy-savings pot gets big enough, it will be put to good use. In the interim, the funds are saved or used to pay down debt. The major portion of the spending gain from the decline in energy prices is coming, but it will take time to filter into the economy.

While consumers were counting their savings, energy companies were getting crushed. Much of that $100 billion came out of their pockets, causing cash flow and earnings to decline precipitously. They reacted by cutting back on one item they could reduce easily: capital spending.

In addition, oil firms attempted to reduce supply so prices would stabilize, if not rise. They slashed the number of oil-producing rigs by 60 percent over the year. The industry retrenched quickly.

Cutbacks in oil-patch capital spending and production rippled across the economy. Firms that supply goods, services, machinery, technology, steel, and anything else you can imagine that goes into building or maintaining oil-production facilities saw their demand decline as oil companies tightened their belts. That's one significant reason the manufacturing sector has lagged this year.

But it didn't end there: Our exports also were hurt. Other oil-producing countries depend heavily on petroleum dollars, and the price drop cratered their economies, which reduced their demand for U.S. goods.

Let's summarize: Lots of money that had been going to pay for energy remained in consumers' pockets, but people didn't start shopping till they dropped. Energy companies retrenched rapidly, however, and the negative effects of declining business spending were felt immediately.

It seems that lower energy prices are bad, right? Initially, that was true because of large energy company losses and spending reductions. But the immediate effects from the energy-sector cutbacks have largely run their course. Rig counts are increasing, and the decline in investment is largely behind us. On the other hand, consumer confidence is rising and some energy savings are flowing into big-ticket purchases such as vehicle and home sales. The negatives are behind us; the positives are kicking in.

Just as higher energy prices transferred income from consumers to energy companies, the drop in prices reversed that outflow. Over time, consumers will spend that largesse, and when they do, watch out.

Rising consumption, fueled in part by lower energy costs, is a major reason there could be broader-based, robust growth going forward. Oil demand and energy company spending will rebound when that happens.

The net result: Because of the better-balanced growth, the economy is better off with lower energy prices.