Oil Barrels
Markets and Economy

How Rising Oil Prices Could Affect the Economy

Oil prices are on the rise. But unlike past price fluctuations when supply shocks caused problems for the economy, today’s increasing prices are based on growing demand. Innovations in technology coupled with a rapid increase in global vehicle sales point to economic growth as the cost of fuel rises.
Jim Glassman, Head Economist, Commercial Banking
November 29, 2017

When oil prices collapsed in late 2014, the energy sector—and the economy at large—initially suffered as capital investment in exploration came to a halt. But because the United States is a net importer of oil, lower prices eventually created broader benefits, notably at the gas pump. The windfall for consumers generated as much as a full percentage point of GDP growth this year.

As oil prices now approach $60 per barrel on their way to recovery, concerns over impending economic disruptions seem unwarranted. Oil’s rise today is being driven by a steadily growing global economy that’s creating new demand for energy. As demand rebalances with supply, oil prices are projected to climb gradually in tandem with broader economic growth.

Remembering Past Supply Shocks

History provides good reason to be wary of sudden shifts in the energy market. Many Americans can remember the painful 1973 oil crisis, when energy prices skyrocketed following coordinated production cuts among OPEC members. This supply shock caused widespread strain on household budgets.

More recently, the 2014 oil glut created severe dislocations in the energy sector. As oil prices dropped to half the average levels of the previous decade, businesses connected to the petroleum industry cut back on exploration and development. During this time, the number of active US drilling rigs fell to 300 from 1,500. Since then, overall capital investment in the American economy fell to 12.5 percent from 13 percent of GDP.

While price relief at the pump has prompted a gradual rise in consumer spending, the short-term pain of deflating oil prices was felt immediately: oil rig workers were laid off, oil patch towns withered and energy stocks tumbled.

Why Today’s Rise in Oil Prices Is Different

Today’s market dynamics are different. Rising prices are due to strengthening global demand for energy rather than a drop in supply, which is less likely to cause sudden economic dislocations.

Despite last December’s agreement between Russia and OPEC to curtail production, supply from OPEC nations has since climbed by 1 million barrels a day, returning to the 43.5 million barrels a day seen prior to last winter’s cuts. Meanwhile, domestic output has climbed back to 9.5 million barrels a day, marking a full recovery from the global supply glut of 2014.

The Future of Demand

In the coming decade, global demand for oil will likely continue to rise, supporting firmer prices. This demand will be led in part by the spike in global automotive sales, which topped 94 million vehicles in 2017—a rise of about 50 percent over the past decade. Consumption is projected to climb from the current 98 million barrels a day to 115 million barrels a day in 2027. As developing economies grow richer, the emerging middle class will consume ever more energy.

Stronger demand is likely to support modestly higher prices at the pump, but it should be accompanied by disproportionate growth of the broader economy. Technological advances are helping the economy become more efficient, stretching the utility of every barrel of oil; the amount of petroleum associated with each dollar of real GDP has fallen by half since 1990.

As oil prices stabilize and edge back above $60 per barrel, the energy sector should boom. Decades of research and development have pushed down the break-even cost of unconventional horizontal drilling, and rising prices will support more exploration in America’s shale fields.

Meanwhile, American businesses will benefit from a stronger market for goods and services abroad. Marginally higher fuel costs are likely to be offset by broader economic growth. Gasoline prices may rise, but the growing economy will likely blunt the pain for most households.

View our economic commentary disclaimer.

 

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