October 26, 2016
Effects of Lower Oil Prices
Oil production, refining, and trade are important parts of the
U.S. and the world economies. Crude oil is an important
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
However, the price of oil has proven to be unstable and
volatile, both in the short- and long-term. Oil prices respond
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
to oil traders who wish to trade oil based on these
expectations, which, when trading occurs, are then
incorporated in the real price of oil.
Although, in reality, there are many prices of oil,
determined by the quality of the oil, reflecting its viscosity
(light to heavy) and its sulfur content (sweet to sour), and
its location and contract timing, the most commonly
discussed grades of oil are the reference crudes. These are
West Texas Intermediate (WTI) for the United States, and
Brent for the rest of the world. The market price of any
particular crude oil on the world market is the price of
Brent plus a premium, or minus a discount, based on the
particular characteristics of the crude oil to be traded.
No country’s oil market is isolated from the world market.
Price movements on the world market affect domestic
prices. Oil is likely to be exported if it can bring a higher
price on the world market. Similarly, imported oil will
bring the world market price into the domestic market and
domestic crude oil will adjust to meet the price of imported
According to the Energy Information Administration (EIA)
monthly spot price data, the price of a barrel of Brent crude
oil peaked at $111.80 per barrel in June of 2014. Declining
prices began in July of 2014 and by December 2014 the
price of a barrel of Brent averaged $62.34, a decline of over
40%. The price of Brent continued its decline into 2015,
averaging $38.01 per barrel in December 2015, a decline of
an additional 40%. Lower prices continued into 2016 with
the price of Brent averaging about $40 per barrel over the
first seven months of the year.
Figure 1. Spot Price of Brent Crude Oil, 2010-2016
(Dollars per Barrel)
Source: EIA. Graphic created by CRS.
The price of a barrel of WTI tended to track movements in
the price of Brent over the period, although the price spread
between the two reference crude oils did vary.
When it began to become more apparent that oil prices were
not likely to quickly return to June 2014 levels, industry
analysts and others began to speculate as to when the oil
market might attain “balance” at a new long-run price.
Could producers, notably the Organization of the Petroleum
Producing Countries (OPEC) broker an agreement among
its members to cut production to support prices, and, if not,
what might be the effects of lower oil prices on the U.S.
Benefits and Costs
In the U.S. context, the most apparent benefit of low crude
oil prices is lower prices for gasoline. The cost of crude oil
accounts for about one half to two thirds of the retail price
of a gallon of gasoline, depending on the level of crude oil
prices. The EIA has developed a rough rule of thumb which
estimates that for each $1 change in the price of crude oil,
the price of gasoline changes by $0.024 per gallon. EIA
data show that regular retail gasoline prices were $3.692 per
gallon in June 2014. Prices fell to $2.543 per gallon by
December 2014 and averaged $2.038 per gallon in
December 2015. Regular gasoline prices averaged $2.155
per gallon over the first eight months of 2016.
If consumers maintain the same driving habits, a fall in
gasoline prices frees disposable income that can be spent on
other goods and services, potentially stimulating the
economy. Alternatively, households might use reduced
gasoline expenditures to reduce their debt, again possibly
benefiting the economy. Some macroeconomists believe
that secondary rounds of increased spending might also
result from the initial consumer spending increase, due to
Effects of Lower Oil Prices
reduced fuel costs, further enhancing potential economic
It may be that some of the macroeconomic benefits of lower
prices were not realized in 2014-2016. U.S. average GDP
growth was 2.4% in 2014 and 1.8% in 2015 and continues
to be relatively weak in 2016. This may be because
consumers chose, in the face of lower gasoline prices, to
buy larger, less fuel-efficient vehicles, which increases
spending on gasoline, or to increase the average miles
traveled per household, again increasing gasoline
consumption. Some might claim that, in addition, increased
automobile use, spurred on by lower gasoline prices, had
deleterious environmental effects resulting from increasing
emissions per vehicle.
Because gasoline and petroleum products are important
consumer commodities, as well as being production inputs,
in the form of petrochemicals, for example, in a wide
variety of other industries, they help determine the over-all
rate of price inflation. The recent decline in oil prices has
contributed to relatively low inflation rates. However, as the
Federal Reserve tries to craft policies to avoid deflation,
rather than inflation, some see this as a mixed benefit for
the macro economy.
Low oil prices have created financial stress in the U.S. oil
industry, especially among independent firms involved in
new oil production. The newest U.S. oil production of the
past five years, in the Bakken and Eagle Ford fields, as well
as output expansion from the Permian Basin, and deep
water production, has been high-cost oil. As the price of oil
fell in 2014-2015 some producers, operating with high
leverage, found it difficult to continue operating. On the
one hand, low prices have stimulated the search for
production cost saving, but they also have resulted in
increased numbers of firms filing for bankruptcy protection.
It was reported that 102 North American oil and gas
producers filed for bankruptcy between January 1, 2015,
and August 31, 2016. This total represented about $66.5
billion of aggregate debt.
Low oil prices have affected U.S. oil production. Total U.S.
crude oil production reached a peak of 9.63 million barrels
per day in April 2014. By July 2016 U.S. production had
declined to 8.68 million barrels per day, a decline of almost
1 million barrels per day. Decreased oil production has
resulted in fewer jobs. It was reported that nationwide over
100,000 jobs in the oil sector disappeared in 2014-2015. In
North Dakota’s Bakken field in August 2016 there were
about 27 drilling rigs operating, down from 190 rigs two
years earlier. Each rig that is taken out of operation results
in about 120 lost jobs.
As jobs in the oil industry are lost, workers tend to leave the
oil producing region, taking income and purchasing power
with them. Jobs in the businesses that support oil workers—
restaurants, food stores, apartment complexes and motels,
and a wide variety of other retail service and goods—all
suffer reduced incomes and job opportunities which can
result in a downward regional economic spiral.
Declining oil prices have also put pressure on state tax
revenues. It has been reported that Texas has lost $6 billion
in oil tax revenue since oil prices began to fall; North
Dakota has lost $3.3 billion; Alaska has lost $2.5 billion,
New Mexico has lost $1.1 billion; Louisiana and Wyoming
$900 million each; and Oklahoma has lost $700 million.
Alaska, Louisiana, and other states have experienced
budgetary problems as a result of lost oil revenues.
As jobs and workers were reduced, localities in oil
producing regions also saw reductions in local sales and
property taxes, putting a strain on local government service
One of the most important effects of lower oil prices has
been that oil companies reduced capital budgets for
exploration and development of new oil supplies. Capital
budgets were reported to be cut by $250 billion in 2015 and
a further $70 billion in 2016. These spending cuts are likely
to have both short and long-run effects on the oil market.
Capital budget cuts are a result of oil companies attempting
to maintain net income in the face of declining revenues.
However, the failure to maintain oil reserves, generally the
highest value asset on oil company balance sheets, will
reduce the value of these firms over time. In addition, the
cutback in oil exploration and development has ripple
effects through the industry affecting oil service companies
and a wide variety of contractors that support oil
From a national and world market perspective, the failure of
oil companies to maintain capital spending is likely to set
the stage for future rounds of higher oil prices. World oil
demand, nearly 100 million barrels per day in 2016, is
likely to continue to increase. Eventually, if demand growth
is larger than oil supply growth, the current supply glut will
transform itself first into a balanced market, then into a
market shortage, creating conditions ripe for sharply
increasing prices. As a result of the estimated three to five
year lag between the launch of a period of intensifying
exploration and the development and availability of new oil
supplies, higher prices could be likely to prevail for a
significant period of time.
While lower oil prices have benefited many sectors of the
U.S. economy, the benefits have not been costless. The
most important cost might be the damage to the U.S. oil
industry now, which might affect oil prices and production
in the future.
Robert Pirog, Specialist in Energy Economics
Effects of Lower Oil Prices
This document was prepared by the Congressional Research Service (CRS). CRS serves as nonpartisan shared staff to
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