The Impact of Oil Price Change on the US Economy - Essay Example

Vulnerability of US economy and impact of oil price hikes ABSTRACT The study seeks to assess the basis in supply and demand for the vulnerability of the United States economy to oil price hikes as well as describe how an oil price hike will impact on the US economy. For the said study objectives, the study reviewed the most recent documents of the US government, an international agency focused on the world oil market, and a non-profit organization focused on the same. Based on the data of the agencies mentioned, oil production has reached a peak and will likely slow down for the next 30 years given demand that may increase with population growth and economic growth itself. The condition provides the basis for US vulnerability to oil price hikes. Based on US economic history and studies of that history, the likely impact of oil price hikes in the US would be to decrease growth, raise inflation, and negatively affect both the oil-dependent and less-oil-dependent industries. Nevertheless, a bright side is that there is a one class of studies that argue that the effects of an oil price hike are moderating through time and would likely moderate even more if monetary policies that accompany the oil price hikes are not so tight. Vulnerability of US economy and impact of oil price hikes Table of content Section Page Abstract i Table of content ii List of tables iii List of figures iii I. Introduction 1 II. Review of literature 1 III. Methodology 2 IV. Results A. International demand and supply of oil 3 B. Lessons from recent history: oil prices and US economy 7 C. Trends and vulnerability of the US to oil price hikes 8 D. Current oil situation and prospects 11 E. Likely impact of oil price increase to the US economy 12 V. Conclusion 14 Bibliography 16 List of tables Number Title Page 1 Global oil demand and supply in million barrels a day, 2006-2010 5 2 Disturbance to the oil market, 1950-2005 6 3 Energy price movements in the last 2-3 years and forecast 12 List of figures Number Title Page 1 Oil production and forecast up to 2050 4 2 World oil production, 1985-2009 7 3 US oil production covering 48 states 1935-2007 except Alaska and Hawaii 8 4 Alaska production of oil 1973 o 2007 9 5 Actual and forecast discoveries of oil in billion barrels, 1900 to 2030 9 6 US oil prices, January 1986 to January 2009 10 7 Key figures on world demand and supply for oil 11 8 Crude prices in $/bbl 11 9 Impact of oil price increases on US economy, 1970 to December 2009 13 10 Global oil demand and world real GDP growth 14 Vulnerability of US economy and impact of oil price hikes I. Introduction Oil prices have been a serious concern for the United States economy. This is because US demand for oil is about 2.9 gallons per day per capita while world average is only about 0.6 gallons a day. Immediately available data indicate that the US oil demand constitutes around 25% of world demand. In contrast, however, the US contributes only about 10% to total world supply for oil. Oil crises have been blamed as the root cause of a number of economic crises in the US as well as in other parts of the world. The subject of this work is not something novel. This work seeks to merely describe why the US is vulnerable to oil price hikes and how an oil crisis would affect the US economy. An appreciation of US vulnerability to oil price hikes is not something that is the sole concern of the US. One estimate of the US economy is that it is about 30% of world output. Knowing US vulnerability to oil price hikes is one way of assessing the world’s vulnerability to oil price hikes as the US economy also affects the world economy. II. Review of literature So many works has been produced on the subject of oil price hikes and the US economy. We identify the works done in 2009 without claim that this work had sought in the first place to make an exhaustive literature review on the subject. A literature search done by the author of this work suggests that there had been two works on the subject in 2009: one is a work by M. Katayama and another is work by I. Fukunaga. Katayama has pointed out or affirmed that since World War II, nine out of ten recessions in the United States has been preceded by dramatic oil price hikes (2009, p. 2). Katayama qualified, however, that output response to oil price shocks tends to be weaker through time because of deregulation in the energy sector, overall improvements in the use of energy, and decrease in the persistence of the oil price shocks (2009, p. 1). Meanwhile, Fukunaga et al. (2009) has found that the effect of an oil price shock on the US industries works this way: a negative supply shock or disruption of supply for oil-intensive industries and as negative demand shock for less oil-intensive industries. This work meanwhile seeks to identify the underlying reasons for US vulnerability to oil price hikes as well as describe the likely impacts that an oil price hike will have on the US economy. III. Methodology This paper seeks to address several key questions. Based on international and US demand and supply data, is the question regarding the possible impact of an oil price hike on the US economy a relevant question? Relatedly, is the US really vulnerable to an oil price hike? Why or why not? Finally, what is likely impact of an oil price hike on the US economy based on the most recent and authoritative literature? Thus, there are two fundamental research objectives that this work seeks to address: 1) Assess based on data whether the impact of an oil price hike on the US economy is indeed a relevant question; and 2) Anticipate based on the most recent and authoritative studies the possible impact of an oil price hike on the US economy. In addressing the research questions and objectives, the work will review agency documents, data, and studies. Admittedly, the methodology that this study adopted for its inquiry is relatively inexpensive. Nevertheless, the methodology is appropriate for the scope of work. At the international level and at the level of the US economy, several adequately funded government and non-government agencies are working to monitor the US economy and the likely impact an oil price hike will have on the economy. In the United States, one of the several government agencies monitoring the oil industry and its possible impact on the economy is the US Department of Agency (DOE) and its Energy Information Agency (EIA). At the international level is the International Energy Agency (IEA) that is monitoring oil prices, supply, demand, and production at the international level. In the US, one not-for-profit organization that is focused on the oil industry and that is continuously building a database on the industry is the International Study for Energy and Our Future (ISEOF) based in Fort Collins, Colorado. All three organizations have good reputation for having a good database on the oil market at the international and country levels. The author believe that the database in the agencies mentioned, especially if supplemented by perspectives from other studies, would likely be able to generate insights that can address the research questions and objectives of this study. IV. Results A. International demand and supply of oil Figure 1 on the next page indicate that as per the estimate being considered by the by United States Department of Energy’s (DOE) Energy Information Agency (EIA), world oil production has reached its peak in 2010. If the figures and estimates are correct, figure 1 suggest that from year 2010 world oil production will be decreasing. This data alone makes it clear that the United States and even the world will be vulnerable to oil price hikes as world production slows down given an increasing population. Figure 1. Oil production and forecast up to 2050 Source: Energy Information Administration 2004:12 Table 1 on the next page are the demand and supply figures for oil in terms of million barrels of oil a day. Latest figures (2009 figures) indicate that while world demand averaged to about 85 million barrels a day in 2009, world supply averaged 84.9 million barrels. This indicates that the margin of surplus is relatively small at 0.1 million barrels a day. However, it must be stressed that the figures should be analyzed within a context. Firstly, we have pointed out earlier that 2010 appears to be the peak of oil production and, henceforth, daily production of oil would decrease from 2010. Secondly, it must be pointed out that Table 1 also shows that although average daily oil production for the entire 2009 exceeded demand by 0.1 million barrels, daily demand exceeded supply on two quarters of 2009: on the third quarter as well as on the 4th quarter. Thus, there a small production surplus for the year but on a per quarter basis, there are two quarters or a period of six moths in which demand has outstripped supply. Table 1. Global oil demand and supply in million barrels a day, 2006-2010 Source: International Energy Agency 2010a: 52 Table 1 also indicates that there are other periods in which demand exceeded supply but we do not have to belabour on the point. Meanwhile, Table 2 indicates that other than demand and supply gaps, another important factor that makes the US economy vulnerable to an oil price hike is disturbance. The disturbance is usually political but the disturbance can be climatic or natural---such as Hurricane Katrina in 2005. The political disturbance can cost the world a thousand million barrels of oil. The political disturbance can be international but even a local one can mean a significant loss of oil supply to the world of up to 900 million barrels. Table 2. Disturbances to the oil market, 1950-2005 Source: Mulder et al. 2007:44 Figure 2 on the next page simply validates Table 1 on page 5 as well as Figure 1 on page 4. The story highlighted by Figure 2 that were drawn from figures and data of the US Department of Energy and Energy Information Agency is the world oil production had apparently reached its peak this 2010. This implies that from henceforth, supply will be tight and stresses the vulnerability of not only the United States but of the world to oil price hikes. Figure 2. World oil production, 1985-2009 Source: US-EIA data as compiled by ISEOF 2009 p. 4 B. Lessons from recent history: oil prices and US economy In the review of literature we note that Katayama 2009 has affirmed that 9 out of 10 recessions in the US have been associated with an oil price hike. In particular, an oil price hike has preceded 9 out of 10 recessions. Hamilton (2009, p. 1) added that the consequence for the US economy of oil price hikes consist in a significant decrease in overall consumption spending, decrease in domestic purchase, and an economic recession. Meanwhile, Hess (2000) reported that the main effects of oil prices in the 1970s are that it lowered real GDP growth and increased the inflation rate. Nevertheless, while various studies uphold that an oil price hike will cause difficulties for the US economy; a few studies argue that the effect of an oil price hike will be very bad. One of such studies is that by Segal 2007. Segal 2007 argues that: 1) oil prices has never been important as is popularly thought; and 2) the most important route that oil prices affect output is through monetary policy because as oil prices increases monetary authorities raise interest rates thereby affecting output. Segal 2007 argues that when oil prices are not used as excuses to raise interest rates, oil prices do not pass through core inflation and output is not affected. Of course, monetary authorities can also argue that raising interest rates were necessary to ensure that the oil price hikes do not exacerbate inflation and that output would be lower if interest rates were not raised. Nevertheless, at minimum, what the study of Segal 2007 highlights is that monetary policy can exacerbate the impact of an oil price hike. C. Trends and vulnerability of the US to oil price hikes Figure 3 indicates that oil production in the US follows global trend: oil production has reached a peak and, at face value, there is no other direction but for demand to outstrip supply as US oil production decreases and as both population and the economy grow. Figure 3. US oil production covering 48 States 1935-2007 except Alaska and Hawaii Source: US-EIA data as compiled by ISEOF 2009 p. 2 Figure 3 does not include the production figure for Alaska. Figure 4 is the production for Alaska. Figure 4 indicates that Alaskan oil production has been decreasing since 1988 and that, therefore, Alaskan oil production cannot be relied on to confront the general trend of decreasing world and US domestic production of oil. Hawaii is never known as an oil producer and need not be discussed. Figure 4. Alaska production of oil 1973 to 2007 Source: US-EIA data as compiled by ISEOF 2009 p. 2 Figure 5. Actual and forecast discoveries of oil in billion barrels, 1900 to 2030 Source: Association for Study of Peak Oil and Gas as compiled by ISEOF 2009 p. 3 Figure 5 above indicates that given a general trend of decreasing world and US domestic production of oil, oil exploration cannot be relied on to address the problem of decreasing oil production both worldwide and domestic. The forecast for the next thirty years is that oil exploration will yield only small quantity of oil. Figure 6 is expected. With decreasing oil production both worldwide and domestic, the market situation translates into higher prices for oil even if there are periods in which oil prices appear low (which can be explained by various temporary factors such as calamities, disease outbreaks, and the like). In January 2009, however, oil prices were low because of weak demand triggered by a global slump induced by a crisis in the US economy. Figure 6. US oil prices, January 1986 to January 2009 Source: US-EIA data as compiled by ISEOF 2009 p. 4 In summary, the figures under this section affirm that the US economy is vulnerable to being affected by an oil price hike because of a trend of decreasing oil production. The vulnerability is being expressed in oil prices except in the last several months wherein a recessionary situation triggered in the US sub-prime sector caused a weaker demand for oil. D. Current oil market situation and prospects Figures or graphs under this section were examined for possible clues on the likelihood of a large oil price hike in the immediate future. Figure 7. Key figures on world demand and supply for oil Source: International Energy Agency 2010b Figure 8. Crude prices in $/bbl Source: International Energy Agency 2010b Figure 7 suggests that based on demand and supply conditions, an oil price hike is highly like during the second semester of the year. World supply forecast figures for oil are forecasted to be too low compared to world demand figures. As shown by Figure 7 above, the world demand figure for oil is about 87 million barrels of oil a day while world supply figures are not likely to be that high for both the third and fourth quarters of 2010. It is highly likely therefore that the demand and supply figures would exert an upward pressure for oil prices to go up. The same key assessment appears to apply for the fourth quarter of 2010. Table 3. Energy price movements in the last 2-3 years and forecast   Year Percent Change  2008   2009   2010   2011  08-09 09-10 10-11 WTI Crudea ($/barrel) 99.57 61.66 80.74 83.50 -38.1 30.9 3.4 Gasolineb ($/gal)  3.26 2.35 2.84 2.96 -27.9 20.8 4.4 Dieselc ($/gal) 3.80 2.46 2.95 3.12 -35.1 19.9 5.7 Heating Oild ($/gal) 3.38 2.52 2.91 3.10 -25.4 15.4 6.6 Natural Gasd ($/mcf) 13.89 11.97 11.59 12.54 -13.8 -3.2 8.2 Electricityd (cents/kwh) 11.26 11.55 11.50 11.74 2.5 -0.4 2.1 a West Texas Intermediate.   b Average regular pump price. c On-highway retail.               d U.S. Residential average. Source: US Energy Information Agency in http://www.eia.doe.gov/steo 6 May 2010 In summary, what this section indicates is that oil price hikes are not only likely in the long term but they are also likely in the immediate periods. Table 3 even indicate that this assessment jibes very well with the analysis of the US Energy Information Agency although crude prices were lower in 2008 than their prices in 2009 and even with their forecasted prices in 2010 and 2011. E. Impact of oil price increases on the US economy Our earlier discussion clearly establishes that oil price hikes is a highly relevant concern because they will remain a feature of the US economy both in the long-term in the immediate periods. Further, we have shown that the relevant literature have indicated that an oil price hike would likely lead the US or any country to a recession, promote inflation, and negatively affect all industries regardless of whether they or are oil dependent. We qualified, however, that as a class of studies argue that the impact of a hike can be moderated by an appropriate monetary policy and that the negative effects of the hike are being moderated through the years through deregulation, efficient use of oil, and less dependence on oil. This section serves to reiterate the impact of an oil price hike on the US economy through data summaries captured by graphs or figures. Figure 9 summarizes the key impact of oil prices on the US economy. Figure 9. Impact of oil price increases on US economy, 1970 to December 2009 Source: ISEOF 2009 (p. 6) as estimated by Dave Murphy of “The Oil Drum”1 Figure 9 affirms that when oil prices are relatively high, the US economy is usually in an economic recession. In Figure 9, the blue line is real price of oil while the pink bars represent petroleum expenditures as a percentage of the gross domestic product. Thus, Figure 9 suggests that when oil prices are high, much of the gross domestic product or output is spent on oil. The same can also translate to fiscal deficits or leakages in the economy as government increases its spending for oil or as more import expenditures result. Figure 10. Global oil demand and world real GDP growth Source: D. Cohen of International Energy Agency as drawn by ISEOF 2009 p. 7 Meanwhile, Figure 10 highlights an important point: the world’s economies are also correlated with the demand for oil. This indicates the oil is an important ingredient for the economic growth of countries other than the US. This implies that in addition to direct effects, an oil price hike will impact the US economy through the effects of the oil price hike on other countries. V. Conclusion Thus, in view of the foregoing, this work concludes that the impact of an oil price hike is a highly relevant question that must be asked if the United States desires to strengthen her economy. The question is relevant because based on the demand and supply situation for oil, oil price hikes will be a persisting feature in the US economy both the long-term and in the immediate term. In other words, the US is highly vulnerable to the problem given the situation of her demand for oil. We saw in the foregoing discussion that the likely e impact of an oil price hike will be a negative impact on growth, exacerbation of inflation, and negative impact on industries. In the process of addressing the study questions, this work has achieved its study objectives. Bibliography Energy Information Administration (EIA). 2004. Long term world oil supply: A resource base/production path analysis. US Department of Energy: Energy Information Administration. Energy Information Administration (EIA). 2010. Short-term energy and summer fuels outlook (6 April 2010 release). US Department of Energy: Energy Information Administration. Accessed 6 May 2010 from < http://www.eia.doe.gov/steo>. Fukunaga, I., Hirakata, N., and Sudo, N. 2009. The effects of oil price changes on the industry-level production and prices in the US and Japan. IMES Discussion Paper Series 2009-E-24. Tokyo: Bank of Japan. Hamilton, J. 2009. Causes and consequences of the oil shock of 2007-08. Accessed 7 May 2010 from . Hess, G. 2000. Oil and the macroeconomy. Talk prepared for the Shadow Open Market Committee Meeting, 13 November. Accessed 6 May 2010 from . Hirsch, R. 2005. Peaking of world oil production: Impacts, mitigation, & risk management. US Department of Energy Publication. Institute for the Study of Energy and Our Future (ISEOF). 2009. Oil production is reaching its limit: The basics of what this means. Fort Collins, Colorado: The Oil Drum. Accessed 7 May 2010 from . International Energy Agency. 2010a. Oil Market Report. US Department of Energy: Energy Information Administration. International Energy Agency. 2010b Highlights of the latest Oil Market Report (12 March 2010). Accessed 5 May 2010 from . Katayama, M. 2009. Declining effects of oil-price shocks. Working Paper 2009-2. Department of Economics, Louisiana State University: E.J. Ourso College of Business. Mulder, M., Cate, A., and Zwart, G. (2007). Economics of promoting security of energy supply. EIP Papers 12 (2), 38-61. Segal, P. (2007). Why do oil price shocks no longer shock? WPM 35. University of Oxford: Oxford Institute for Energy Studies. Read More