LOW CRUDE OIL PRICES: EFFECTS OF LOW PRICES OF CRUDE OIL

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Abstract

Oil behaves just like other commodities that exhibit wide price swings in periods of oversupply or shortage. Throughout much of the twentieth century, the domestic and international industry prices of crude oil have been greatly regulated through price controls or production. Recent downturn in the prices of crude oil will obviously have the most serious bearings on the exploration segment of the industry. This research paper addresses the impacts of low crude oil prices to the economy and major industries that are dependent, both directly and indirectly on crude oil within the United States.

Introduction

The world requires oil for various purposes such as operating oil-powered irrigation plants, to plant crops in fields using farm machinery, to power automobiles, and also as a raw material for making different kinds of products such as fabrics and medicines (Kilian & Park, 2009). This therefore means that oil is a very essential requirement for any economy to run. Also, the prices of oil have to be standardized to ensure efficient and responsible use of the raw material.

The price of oil is mainly determined by supply and demand, and by expectation. The economic activity closely relates to the demand for energy. It is also important during winter in countries that lie in the northern and southern hemispheres that require heating system to remain warm, and during simmers in countries that require effective air conditioning system. Supply is often affected by geospatial upsets and weather. Whereas low prices can lead to drought in investment, high prices makes produces to heavily invest which eventually boosts the supply.

The American economy is the world’s largest economy. Even though there are a number of factors that directly or indirectly contribute towards the status of the American economy, crude oil plays an extremely pivotal role which cannot be overlooked. Energy consumption is closely connected to both economic progress of the nation and other significant economic indicators such as trade and manufacturing. The significant drop in the prices of crude oil has led to creation of opportunities and threats which have consequently resulted in potential losers as well as several gainers.

The Americans’ appetite towards energy is very insatiable. Though the overall spending ratio on energy to the average gross domestic product has either remained steady in recent years or dropped considerably, such spending still take a huge chunk of household budget. Energy spending still remains a crucial determinant of living standards and critical components of expenses incurred in manufacturing. The United States spends almost two million dollars on crude oil. This figure exceeds 8% of its gross domestic product per annum (Hamilton, 2008). Also, the United States is the leading consumer of crude oil worldwide with an average consumption of twenty million barrels daily. Nearly half of the crude oil consumed daily in the United States is imported from about eighty countries that are members of OPEC (Organization of Petroleum Exporting Countries) while the other half is domestically produced.

After hitting the peak in September 2014, where the price of crude oil was $115 per barrel, the prices have dropped drastically and now oil trades at $47 a barrel (Kilian & Murphy, 2014). This has mainly been caused by the closing gap between the global demand of crude oil and the supply. In the United States, the effect of decreasing oil prices on the country’s economy has been a mixture of good news for oil sensitive industries such as airline, transportation, manufacturing, and American consumers, but also a bad news for countries that are members of OPEC.

According to the Economist magazine, low oil prices will cause a shift estimated to $1.3 trillion from producers of crude oil to consumers. A typical household will experience as much as 2% increase in the annual income since low crude oil prices means the consumer will spend $3000 annually on gasoline and end up saving as much as $1000. Moreover, the low crude oil prices have ensured typical US households have saved up to $75 billion in the last six months, and it is estimated that the savings would increase to $150 billion per year if the prices continue to fall exponentially. This has ensured many Americans are able to channel their savings, into other sectors of the economy, availing an impetus for expansion of business.

However, falling crude oil prices have majorly affected the shale oil industry. This is mainly because the industry’s inability to function and operate effectively, while still making profits when the price of crude oil is below $60 per barrel that is universally regarded as the break-even price (Hamilton, 2008). The hydraulic fracturing boom that was experienced in past years has been able to attract a massive amount real and financial resource into the shale oil production. If the prices of crude oil continue to decrease for a longer period of time, there is high likelihood that the shale industry will experience a massive withdrawal of seal and financial resources that had been injected into the industry. This will consequently compel the shale industry into discontinuing or downsizing their operations unless a breakthrough in the hydraulic fracturing technology. Consequently, the United States Economy will be quietly consequential as a result of this.

Low gasoline prices also have serious consequence on manufacturers of automobiles. This is mainly characterized by a major increase in the overall demand for autos. However, consumers will revert to large vehicles with less gas mileage. To prove this, recent data collected in the United States on sales of autos indicated a significant increase in demand, particularly for pickup trucks.

The United States auto companies are also required to comply with fuel efficiency standards for their automobiles. The current administration, led by President Obama has been adamant in its policy of pushing for upper efficiency standards, particularly after year 2010 when the price of pump surged to approximately $4 per gallon. Nonetheless, whenever there is a decline in the gas prices, the country experiences a loss of momentum in regard to concern for fuel efficiency. This in turn increases the flexibility of the administration towards the energy policy.

It is projected that the US will become the world’s largest producer and exporter of crude oil in few years to come (Karmee & Chadhaa, 2008). Apart from the boom in hydraulic fracturing, the government has been putting a lot of efforts in addressing environmental awareness and promoting public awareness so as to diminish the dependency of the country on crude oil from Middle East, which is considered as the most volatile region of the world. Moreover, low crude oil prices has offered a momentous chance for the Federal Government to rethink about its energy policy that has enforced restrictions on exports of natural gas, oil, and other related products. Also, massive tax breaks and subsidies are being given to individuals who work on alternative energy sources and oil companies. As the prices of crude oil sink, the United States government should re-examine these policies and if possible, relax the subsidies.

References

Kilian, L., & Murphy, D. P. (2014). The role of inventories and speculative trading in the global market for crude oil. Journal of Applied Econometrics, 29(3), 454-478.

EIA, U. (2013). Annual energy outlook 2013. US Energy Information Administration, Washington, DC.

Hamilton, J. D. (2008). Understanding crude oil prices (No. w14492). National Bureau of Economic Research.

Kilian, L., & Park, C. (2009). The impact of oil price shocks on the us stock market*. International Economic Review, 50(4), 1267-1287.

Karmee, S. K., & Chadha, A. (2005). Preparation of biodiesel from crude oil of Pongamia pinnata. Bioresource technology, 96(13), 1425-1429.