Federal Reserve
The U.S. Federal Reserve System's “Beige Book” revealed Wednesday that tumbling oil prices are beginning to show negative effects in regions that operate heavily within the energy industry after oil firms reported layoffs and hiring freezes. Reuters/Jonathan Ernst

Plunging oil prices since June are beginning to show negative effects in regions that operate heavily within the energy industry, as oil firms reported layoffs and hiring freezes, the U.S. Federal Reserve’s “Beige Book” revealed Wednesday. Oil drilling activity declined in the Fed’s Kansas City district, while the report showed high stockpile levels in crude across the Gulf Coast, a cause for concern for oversupply and less demand.

Economists analyze the Fed’s Beige Book for any indication of when the central bank may raise interest rates, which are currently at historic lows. But the report showed overall price and wage inflation remained modest, while payrolls in a variety of sectors expanded only moderately during the reporting period.

The report, which the central bank publishes eight times a year, highlights the current condition of the U.S. economy within the Fed's 12 districts. It covers a range of economic activity, from manufacturing to construction to wage growth, and offers economists an opportunity to watch for any indication that the U.S. economy is growing stronger or slower than forecast. The Beige Book summarizes comments received from business and other contacts outside the Federal Reserve and is not a commentary on the views of Fed officials.

Energy Firms Report Layoffs, Hiring Freezes

Dallas, the Fed’s 11th district, said hiring was slightly less widespread than in the previous report, while businesses reported hiring freezes and layoffs. Meanwhile, demand for oil field services fell in the 11th district, and declines were concentrated in the Permian Basin as firms moved away from traditional vertical drilling. The Eagle Ford basin, located in South Texas, also saw a slight drop in activity.

“Outlooks for the first half of 2015 are very uncertain and significantly weaker than in the prior reporting period, with firms expecting anywhere from a 15 percent to 40 percent decline in demand for their services,” the Federal Reserve said in the report Wednesday.

Although commercial real estate activity expanded in most of the Fed’s districts, the Dallas district noted that office leasing activity remained strong; but one contact noted a slight pullback in demand from oil and gas firms.

Oil Drilling Activity Declines

Kansas City, the Federal Reserve’s 10th district, said oil drilling activity declined, and firms expect the district's energy sector to slow further in response to lower energy prices.

The district's energy industry also slowed in December. Most businesses reported lower drilling activity, while demand for oil field services fell. Oil rigs decreased marginally while natural gas rigs increased. “Future drilling activity, employment and capital expenditures were projected to be significantly lower in response to lower oil prices,” the report said.

While the price of U.S. oil has dropped more than 40 percent in the last seven months, trending below $50 a barrel after peaking at more than $100 in June, it’s expected to fall further through early 2015. Firms' opinions were mixed about oil prices one year out, but on average they expected a rebound of $15 to $20 per barrel from year-end 2014 levels. A few firms reported increased difficulties accessing credit due to lower oil prices, according to the report.

High Inventory Levels Across Gulf Coast

Atlanta, the Federal Reserve’s sixth district, said supply of crude oil and natural gas continued to outpace demand, leading to high inventory levels across the Gulf Coast.

Industry contacts in the energy sector reported that the downturn in the price of oil has influenced their outlook and strategic planning for 2015, including increased focus on cost management and faster, more efficient drilling techniques.

Exploration and production firms shared plans to continue drilling operations across the Gulf Coast and in Louisiana in 2015, though they intend to approach projects more cautiously. The same goes for oil service companies in the region, which are evaluating cost-reduction strategies if low energy prices are sustained.

The Beige Book report comes after oil prices extended their rout Wednesday, after U.S. crude oil inventories surged to an 80-year high. U.S. commercial crude oil inventories rose by 5.4 million barrels from the previous week. At 387.8 million barrels, the inventories are at their highest level (for this time of year) in at least 80 years, the U.S. Energy Information Administration said Wednesday.

Low Gasoline Prices Mixed

Falling crude oil prices have helped send the average price of gasoline down to $2.09 per gallon across America, according to Gasbuddy.com. But reports on the impact of lower gasoline prices were mixed and many firms were uncertain about sales expectations for the first quarter of 2015. Another surprise in the report: General merchandise retailers in the Fed’s New York district said sales were “largely sluggish” and below expectations for the holiday season.

Auto dealers in Atlanta said lower gas prices quickly boosted purchases of larger vehicles; however, some dealers in the St. Louis district reported excess inventories of luxury cars. Auto sales in Kansas City dropped during the reporting period, but remained higher than a year earlier.

Up Next, The Fed's January Policy Meeting

Each of the Fed’s Beige Books is published two weeks before the Federal Open Market Committee (FOMC), which is composed of the Fed's seven boards of governors and five Reserve Bank presidents. The FOMC's first policy meeting of the year is Jan. 28-29.

Policy officials in the Beige Book said they saw the economy moving at a “modest to moderate” pace, unchanged from the Fed’s previous Beige Book issued on Dec. 3, and consumer spending remained at a “slight to moderate” pace. Most economists expect the Fed to hike rates in mid-2015, but if falling oil prices have a negative effect on an improving U.S. economy, weighing on inflation and wage growth, the Fed could pause before hiking rates.

"The slump in the oil price means that headline inflation is likely to turn negative in the coming months in many advanced economies, just as it already has in the eurozone," London-based firm Capital Economics said in a research note. "In general, deflation in consumer prices should be positive for economic growth. The problems come when deflation is reflected in falling nominal incomes and in asset prices, or when expectations of falling prices become ingrained."