Effects of Lower Oil Prices

Effects of Lower Oil Prices

October 26, 2016
Effects of Lower Oil Prices
Oil production, refining, and trade are important parts of the
Figure 1. Spot Price of Brent Crude Oil, 2010-2016
U.S. and the world economies. Crude oil is an important
(Dollars per Barrel)
indirect component of gross domestic product in the United
States. Oil is a key input in petroleum refining,
petrochemical, and plastics industries, in addition to many
others. The oil industry provides relatively high paying
jobs, is a leading source, and implementer, of new
technologies, as well as being an important component of
world trade. The price of oil, important in its own right, is
also a key component in the costs of a wide variety of
consumer and industrial products, perhaps the most visible,
and important, being gasoline and other transportation
fuels.
However, the price of oil has proven to be unstable and

volatile, both in the short- and long-term. Oil prices respond
Source: EIA. Graphic created by CRS.
to both real, fundamental changes in demand and supply, as

well as changing expectations based on world events. Spot,
futures, and other derivative markets, are readily available
The price of a barrel of WTI tended to track movements in
to oil traders who wish to trade oil based on these
the price of Brent over the period, although the price spread
expectations, which, when trading occurs, are then
between the two reference crude oils did vary.
incorporated in the real price of oil.
When it began to become more apparent that oil prices were
Although, in reality, there are many prices of oil,
not likely to quickly return to June 2014 levels, industry
determined by the quality of the oil, reflecting its viscosity
analysts and others began to speculate as to when the oil
(light to heavy) and its sulfur content (sweet to sour), and
market might attain “balance” at a new long-run price.
its location and contract timing, the most commonly
Could producers, notably the Organization of the Petroleum
discussed grades of oil are the reference crudes. These are
Producing Countries (OPEC) broker an agreement among
West Texas Intermediate (WTI) for the United States, and
its members to cut production to support prices, and, if not,
Brent for the rest of the world. The market price of any
what might be the effects of lower oil prices on the U.S.
particular crude oil on the world market is the price of
economy?
Brent plus a premium, or minus a discount, based on the
particular characteristics of the crude oil to be traded.
Benefits and Costs
No country’s oil market is isolated from the world market.
In the U.S. context, the most apparent benefit of low crude
oil prices is lower prices for gasoline. The cost of crude oil
Price movements on the world market affect domestic
accounts for about one half to two thirds of the retail price
prices. Oil is likely to be exported if it can bring a higher
of a gallon of gasoline, depending on the level of crude oil
price on the world market. Similarly, imported oil will
prices. The EIA has developed a rough rule of thumb which
bring the world market price into the domestic market and
estimates that for each $1 change in the price of crude oil,
domestic crude oil will adjust to meet the price of imported
the price of gasoline changes by $0.024 per gallon. EIA
oil.
data show that regular retail gasoline prices were $3.692 per
Declining Prices
gallon in June 2014. Prices fell to $2.543 per gallon by
December 2014 and averaged $2.038 per gallon in
According to the Energy Information Administration (EIA)
December 2015. Regular gasoline prices averaged $2.155
monthly spot price data, the price of a barrel of Brent crude
per gallon over the first eight months of 2016.
oil peaked at $111.80 per barrel in June of 2014. Declining
prices began in July of 2014 and by December 2014 the
If consumers maintain the same driving habits, a fall in
price of a barrel of Brent averaged $62.34, a decline of over
gasoline prices frees disposable income that can be spent on
40%. The price of Brent continued its decline into 2015,
other goods and services, potentially stimulating the
averaging $38.01 per barrel in December 2015, a decline of
economy. Alternatively, households might use reduced
an additional 40%. Lower prices continued into 2016 with
gasoline expenditures to reduce their debt, again possibly
the price of Brent averaging about $40 per barrel over the
benefiting the economy. Some macroeconomists believe
first seven months of the year.
that secondary rounds of increased spending might also
result from the initial consumer spending increase, due to
https://crsreports.congress.gov

Effects of Lower Oil Prices
reduced fuel costs, further enhancing potential economic
and a wide variety of other retail service and goods—all
growth.
suffer reduced incomes and job opportunities which can
result in a downward regional economic spiral.
It may be that some of the macroeconomic benefits of lower
prices were not realized in 2014-2016. U.S. average GDP
Declining oil prices have also put pressure on state tax
growth was 2.4% in 2014 and 1.8% in 2015 and continues
revenues. It has been reported that Texas has lost $6 billion
to be relatively weak in 2016. This may be because
in oil tax revenue since oil prices began to fall; North
consumers chose, in the face of lower gasoline prices, to
Dakota has lost $3.3 billion; Alaska has lost $2.5 billion,
buy larger, less fuel-efficient vehicles, which increases
New Mexico has lost $1.1 billion; Louisiana and Wyoming
spending on gasoline, or to increase the average miles
$900 million each; and Oklahoma has lost $700 million.
traveled per household, again increasing gasoline
Alaska, Louisiana, and other states have experienced
consumption. Some might claim that, in addition, increased
budgetary problems as a result of lost oil revenues.
automobile use, spurred on by lower gasoline prices, had
deleterious environmental effects resulting from increasing
As jobs and workers were reduced, localities in oil
emissions per vehicle.
producing regions also saw reductions in local sales and
property taxes, putting a strain on local government service
Because gasoline and petroleum products are important
provision.
consumer commodities, as well as being production inputs,
in the form of petrochemicals, for example, in a wide
One of the most important effects of lower oil prices has
variety of other industries, they help determine the over-all
been that oil companies reduced capital budgets for
rate of price inflation. The recent decline in oil prices has
exploration and development of new oil supplies. Capital
contributed to relatively low inflation rates. However, as the
budgets were reported to be cut by $250 billion in 2015 and
Federal Reserve tries to craft policies to avoid deflation,
a further $70 billion in 2016. These spending cuts are likely
rather than inflation, some see this as a mixed benefit for
to have both short and long-run effects on the oil market.
the macro economy.
Capital budget cuts are a result of oil companies attempting
Low oil prices have created financial stress in the U.S. oil
to maintain net income in the face of declining revenues.
industry, especially among independent firms involved in
However, the failure to maintain oil reserves, generally the
new oil production. The newest U.S. oil production of the
highest value asset on oil company balance sheets, will
past five years, in the Bakken and Eagle Ford fields, as well
reduce the value of these firms over time. In addition, the
as output expansion from the Permian Basin, and deep
cutback in oil exploration and development has ripple
water production, has been high-cost oil. As the price of oil
effects through the industry affecting oil service companies
fell in 2014-2015 some producers, operating with high
and a wide variety of contractors that support oil
leverage, found it difficult to continue operating. On the
exploration.
one hand, low prices have stimulated the search for
production cost saving, but they also have resulted in
From a national and world market perspective, the failure of
increased numbers of firms filing for bankruptcy protection.
oil companies to maintain capital spending is likely to set
It was reported that 102 North American oil and gas
the stage for future rounds of higher oil prices. World oil
producers filed for bankruptcy between January 1, 2015,
demand, nearly 100 million barrels per day in 2016, is
and August 31, 2016. This total represented about $66.5
likely to continue to increase. Eventually, if demand growth
billion of aggregate debt.
is larger than oil supply growth, the current supply glut will
transform itself first into a balanced market, then into a
Low oil prices have affected U.S. oil production. Total U.S.
market shortage, creating conditions ripe for sharply
crude oil production reached a peak of 9.63 million barrels
increasing prices. As a result of the estimated three to five
per day in April 2014. By July 2016 U.S. production had
year lag between the launch of a period of intensifying
declined to 8.68 million barrels per day, a decline of almost
exploration and the development and availability of new oil
1 million barrels per day. Decreased oil production has
supplies, higher prices could be likely to prevail for a
resulted in fewer jobs. It was reported that nationwide over
significant period of time.
100,000 jobs in the oil sector disappeared in 2014-2015. In
North Dakota’s Bakken field in August 2016 there were
While lower oil prices have benefited many sectors of the
about 27 drilling rigs operating, down from 190 rigs two
U.S. economy, the benefits have not been costless. The
years earlier. Each rig that is taken out of operation results
most important cost might be the damage to the U.S. oil
in about 120 lost jobs.
industry now, which might affect oil prices and production
in the future.
As jobs in the oil industry are lost, workers tend to leave the
oil producing region, taking income and purchasing power
Robert Pirog, Specialist in Energy Economics
with them. Jobs in the businesses that support oil workers—
restaurants, food stores, apartment complexes and motels,
IF10493

https://crsreports.congress.gov

Effects of Lower Oil Prices

Disclaimer
This document was prepared by the Congressional Research Service (CRS). CRS serves as nonpartisan shared staff to
congressional committees and Members of Congress. It operates solely at the behest of and under the direction of Congress.
Information in a CRS Report should not be relied upon for purposes other than public understanding of information that has
been provided by CRS to Members of Congress in connection with CRS’s institutional role. CRS Reports, as a work of the
United States Government, are not subject to copyright protection in the United States. Any CRS Report may be
reproduced and distributed in its entirety without permission from CRS. However, as a CRS Report may include
copyrighted images or material from a third party, you may need to obtain the permission of the copyright holder if you
wish to copy or otherwise use copyrighted material.

https://crsreports.congress.gov | IF10493 · VERSION 2 · NEW