The Zero-Sum Game in the US Economy

The Zero-Sum Game in the US Economy

The game theory is one of the simplest yet highly influential economic theories.

Introduced by the economist, Oskar Morgenstern, and mathematician, John von Neumann, in their 1944 book ‘The Theory of Games and Economic Behavior’, the game theory has wide implications on trade and the economy.

One of the basic principles of game theory is a zero-sum game. It refers to a situation where the gains and losses are balanced resulting in no net gain or loss.

With the rising oil prices, the US industry at present can be said to be in the zero-sum game as the losses of one sector is balanced by the gains in another.

Oil Price Rise and Effect on the US Economy

On Tuesday, oil prices had edged higher supported by signs of supply cuts by OPEC in April this year. Moreover, the news about a reduction in the US crude output growth had put upward pressure on prices.

OPEC members had agreed to cut supply of oil on January 1 this year. The group had agreed to reduce the supply by about 1.2 million barrels per day (bpd) in the next six months.

Saudi Arabia, the largest exporter of oil, had decided to reduce the oil exports to less than 7 million bpd. In addition, international events such as unrest in Libya have also put upward pressure on the oil prices.

Previously, the US economy was sensitive to oil price gains. A gain in the price of oil resulted in an increase in the prices of goods and services due to higher transport and energy costs. This had a negative effect on the economy – reduced consumer spending, low manufacturing activity, and job losses.

But the situation is different today.

The rise of the US to become the largest oil producing country in the world has changed the calculus for how oil prices affect the US economy.

Coming back to our zero-sum game, the losses due to rising oil prices is balanced by the gain in the oil industry.

The Effect of Rising Oil Prices on the US Economy

An increase in oil prices pushes oil companies to increase capital spending. The negative effect of higher oil prices is offset to a large extent by higher revenues from oil exports.

The US domestic oil and gas production had increased significantly in the past few years due to the fracking revolution.

Net oil imports have started to fall after a steady increase for the past three decades. The fall is largely due to an increase in the production by local shale oil companies thanks largely to hydraulic fracturing, or fracking.

Fracking has allowed oil companies to extract large quantities of oil and gas from a given area. The technique allowed US oil production to increase from nearly 4 million bpd in 2005 to about 12 million bpd today.

Oil exports averaged 2.4 million bpd in December 2018. According to a forecast by the International Energy Agency (IEA), the US will become the largest exporter of oil by 2024, hitting 9 million bpd.

So, higher oil prices are good news for many industries in the US.

According to experts, about 0.2 percent decrease in the economy due to lower consumer spending will be offset by a gain 0.2 percent due to increased capital spending by oil companies. In other words, the positive and negative effects will ripple through the economy resulting in a zero-sum game for the economy.

The recent oil price hike has resulted in a dramatic increase in energy stock prices in the US. The stock prices will rise further in 2019 with a forecasted increase in the oil prices this year.

The link between profitability and oil prices is particularly strong for upstream companies in oil industry. Upstream companies are involved in the oil exploration, drilling, and refining of crude oil. These companies increase investment in times of rising prices due to higher export revenues.

Downstream companies that distribute finished crude oil products to the consumer do not benefit much from rising oil prices. The profit margins of these companies remain stable both in times of rising and declining oil prices.

Higher Oil Prices Linked to Increased Capital Spending in the Oil Sector

Rising international oil prices act as an incentive to extract more oil. The recent increase in oil prices will likely result in a flurry of investment by upstream companies in the US oil industry.

In contrast, the activities in the oil sector decrease in times of low oil prices.

Most shale oil companies cannot survive in times of sustained low oil prices. This is because shale oil is costlier to extract from the ground.

A lot of oil producing companies had suffered during the recent slump in prices when they had hovered near the $40 mark. Many drill operators were forced to cut back production and lay off workers.

The US oil industry had slid into its own recession with low output and revenues. Some oil companies had even filed for bankruptcy protection. Bondholders had suffered significant losses since the debts of the companies were downgraded.

Large oil sector companies suffered less as compared to small companies. This is because they are well diversified and have hedged their activities by investing in financial products.

Financial companies were also hit by the low oil prices. Small regional banks in the oil producing regions such as the Permian Basin in Texas were particularly exposed. Texas banks Cullen/Frost Bankers (CFR) and Texas Capital Bank (TCBI) had suffered huge losses since a large part of the loan portfolio comprised of the energy sector companies.

On Thursday, International Brent price had hit the highest level of the year reaching $67.8 per barrel. In addition, the US West Texas Intermediate (WTI) price had increased to $58.38 per barrel during the day.

The Economic Forecast Agency forecasts that Brent Oil price will reach $70.2 by the end of the year. Oil prices are expected to go above the $100 mark by the end of 2020.

Fundamentals predict that the era of record low prices is over. The higher oil prices will benefit companies in the energy and financial sector in the US. Moreover, investors who put money in energy stocks can expect to ride the wave of rising oil prices in the years ahead.

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