Did you hear? Cheap oil may now be bad for the economy. That’s the question “explored” in a piece at NPR titled, “Oil Prices Hit A New Low. Here’s Why That Might Be A Bad Thing.” Did you notice the application of “might?” Well, it might, but it might not with an emphasis on not.
Related: Has Shale Oil Technology Changed the World?
According to the NPR piece, a drop in oil prices signals global growth is fading. Did you notice that alarming decline in the market? And oh, by the way, our increased oil production puts more of our economy on the hook when the price of crude drops.
“Because the U.S. has become such a large producer of oil, because of the fracking boom and other innovations in drilling … it’s not such an easy thing to say that a drop in oil prices is unambiguously good for the U.S. economy,” said Regan.
Let’s unpack this.
Oil Economics From Another Angle
Cheap oil does affect GDP in nations whose economies rely almost entirely on oil for their GDP. It’s a big deal. So, big, in fact, we can use increased production to the detriment of strategic and historical enemies whose GDP suffers when oil prices drop. There are a few of those on the planet. What impacts them does not impact us.
The American oil and gas industry accounts for about 8% of our GDP. The consumption (and cost) of oil and gas in the United States affects 100% of GDP. Yes, even the so-called green businesses still rely on trucks and planes and ships for logistics. Their employees drive to work in fossil-fuel powered vehicles.
One conventional explanation is that oil price increases lower GDP growth by raising production costs. Alternatively and complementarily, large oil price changes, either increase or decrease, may affect aggregate output adversely because they delay business investment by raising uncertainty or costly sectoral resource reallocation, for example, from more adversely influenced sector to less adversely influenced sector, and such reallocation is costly. (H. Gou and K.L.Kliesen 2005)
This makes clear that crude price increases affect negatively on output and employment, because the increase acts as a tax on consumption. Moreover, firms facing higher costs, increase prices for their products, which means (an) increase in inflation.
Production and Predictability Matter
Another point NPR ignores when we’re talking business cycles, costs, and GDP is volatility. Availability. Predictability. Businesses that can plan for changes perform better.
If output growth slowed because of uncertainty delays investment in capital goods, this brings another result, since employment growth tends to be highly dependent on output growth, price volatility decreases employment growth and increases unemployment rate.
Price volatility influences financial markets both directly and indirectly. Actual as well as anticipated changes in economic activity, corporate earnings, inflation, and monetary policy following the oil price increases will affect equity and bond valuations, and currency exchange rates. (FT, 2008)
The current drop in the market looks like an ordinary correction. Profit-taking after a long steady growth in value. Given all the other economic indicators, and thanks to cheap oil and less volatility, market growth should continue. GDP should also remain in (never to be seen again “but yet here we are”) territory.
Fracking Matters
Another factor ignored, and one that is critically important is production. No matter what the cost of oil per barrel the country producing the most of it will always be redistributing global wealth to its shores.
The last of the cost component is a transfer of wealth from oil consuming to oil producing countries. The phenomenon definitely worsens the terms of trade, and it reflects the fact that consuming nations have to trade more resources for the same quantity of oil due to the exercise of monopoly power by the oil producers. The transfer of wealth is not seeing as a loss of the worlds economic output since resources lost by consuming nations is kept by producing nations. It is, however, a real economic loss to the consuming countries.
The United States is currently the leading producer of oil in the world. A distinction that matters. Exporting at any price moves money to the US instead of away from it. Further ramping up refining capacity would multiply the benefits. Keeping our money here. Bringing more foreign dollars to our shores. When foreign economies slow down ours is buffered.
Thank Fracking. This segment of the oil industry is responsible for our new status as a global production leader. An industry sector that has become incredibly fleet of foot with an eye toward efficiency. With the ability to ramp up or down within weeks. A massive oil reserve in the ground we can tap when needed to offset volatility in price and production.
What About My GDP?
When oil is cheaper, I spend less on gas. I pay less to heat my home. My employer spends less on that critical operating expense. That savings (we’ll call it crumbs) increase real or perceived disposable income for a super-majority of Americans. That money either finds its way into savings (investment) or gets injected right back into the economy.
Cheap oil was always good for the US. Now that we are the largest producer of the stuff it’s even better. You can’t run a modern economy without it and its cost ways heavy on every sector of an economy. So feel free to dismiss these experts who, not unlike the climate variety appear ready to say or do anything to get attention, money, or to simply put another sliver in the minds of the public. Things aren’t that great.
But they are.
H/T Oil price fluctuations and its effect on GDP growth – A case study of USA and Sweden
Related: As a Matter of Fact – We Can Drill Our Way To Cheaper Energy (So Drill baby Drill!)
