Why Lower Oil Prices Are Good for the Economy

The latest oil shock has hit the energy patch hard, causing energy stocks to decline. While the prolonged downturn in crude has been bad for oil companies, it is having a positive effect on the economy. 

Now what?

You see, petroleum and its derivative products form an important part of our daily lives and the modern economy. Energy is the fundamental input for basically every economic activity, and oil provides the fuels needed to generate that energy as well as essential lubricants and packaging materials.

This means that when the price of oil falls, so too do the costs associated with a range of social and economic pursuits. That makes lower oil prices a form of fiscal stimulus, providing a greater incentive for consumption. U.S. economists have estimated that every one-cent reduction in the price of gasoline puts roughly US$1 billion in the hands of U.S. consumers, and a similar phenomenon is occurring in Canada.

This explains Canada’s strong economic growth in April when GDP expanded by 3.3% year over year.

One industry that performed particularly well was mining, which saw its share of GDP grow by 12% compared to a year earlier. Cheaper fuel, along with the rally in coal, base metals, and gold, created a significant increase in profitability, driving higher activity. This is highlighted by Teck Resources Ltd.’s (TSX:TECK.B)(NYSE:TECK) first-quarter 2017 results where net profit grew by an impressive $653 million compared to a year earlier.

Manufacturing also performed well; its contribution to GDP expanded by 2% compared to a year earlier.

Overall corporate profits, according to data from Statistics Canada, continue to grow, rising 9% year over year for the first quarter with most of that growth coming from non-financial industries.

This has led many pundits to speculate that a rate hike is on the way, which was confirmed by comments from Bank of Canada governor Stephen Polz. He indicated that he favours lifting rates by half a percentage point, which should lead to a stronger Canadian dollar and higher bond yields.

So what?

The prolonged slump in crude, while clearly having a sharp impact on the energy patch, has been a boon for other sectors of the economy. It is a key driver of the sustained economic recovery that is underway and will help to promote further consumption, which is beneficial for the economy and, in particular, the manufacturing and financial sectors.

One of the best ways for investors to gain exposure to greater rates of economic growth is by investing in Brookfield Infrastructure Partners L.P. (TSX:BIP.UN)(NYSE:BIP). It operates a global portfolio of infrastructure assets that are critical to the economy, including toll roads, telecommunications towers, ports, rail, and electricity as well as natural gas transmission utilities. As GDP grows, so will the demand for the use of that infrastructure, ultimately giving Brookfield Infrastructure’s bottom line a healthy bump.

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Fool contributor Matt Smith has no position in any stocks mentioned. Brookfield Infrastructure Partners is a recommendation of Stock Advisor Canada.

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