Oil, You And The Economy

In the middle of December, the drastic drop in crude oil prices started a series of end-of-the-year predictions. Many thought a long-term depression in oil prices would lead to economic issues in the US. Now a good way into the first quarter of the year, the International Energy Agency has stated that oil should stay around $55 per barrel for most of 2015. 

The price for oil is lower and has already hit a new six-year low, without accounting for inflation. With inflation, we’re talking about oil prices that rival the prices of the mid 1980’s. Think about the last time you paid so little to fill your gas tank. Now think about what other items cost at that time. This is when economists ask serious questions. How did the price of oil drop so suddenly? What does this means for the economy?

How did it drop so suddenly?

Long story short: Demand in Asia and Europe is tapering and North American shale oil production has allowed the US and Canada to become major producers in oil again. That’s a simple, superficial evaluation, but it doesn’t account for the speed and severity of the drop. Bruce McCain states that the drastic drop is indicative of a waning global economy. A weakened market means that demand has slowed at an unexpectedly severe rate.

On the other side of the equation is the development of hydraulic fracturing technology in recent years. According to the Department of Energy, up to 95% of new oil and gas in the United States are being hydraulically fractured, a technique that gives access to reserves that traditional drilling cannot access. Fracking has boosted the US production of oil by 45% over the last four years and Canadian production by 25% in the same time. The world-wide demand for oil has risen by a modest 4% since 2010, yet the North American supply has increased by 38% in comparison.

The North American production infrastructure was developed while oil was double its current value, but it is being met by a world that doesn’t need as much as is flowing out right now. Wouldn’t other producers just cut production rates? Normally, yes. For now, OPEC has decided to keep producing, effectively promising high output no matter how cheap oil becomes. OPEC will not drop its projected production despite the disproportionate growth of supply and demand.

What Does This Mean for the Economy?

Hydraulic fracturing of shale oil has led to the increased supply, but it’s also an expensive extraction method. For shale oil producing areas, the drop in crude oil prices has resulted in job losses for North Dakota, Wyoming, Alaska, Oklahoma, and New Mexico, just to name a few. Many of these areas became boom towns while the price of oil remained high, but low prices present a large employment risk for what are often isolated regions. States, and particularly regions, where oil is the main industry will see the biggest impact of lower prices because there will be less reason to employ as many people as were hired on in the last few years.

Luckily, the majority of the population does not live in an oil-dependent community. The economy at large will not take a hit from oil price reductions. For many working-class families, cheap oil will have positive impacts. Those who commute by car can expect to stash away more into their savings, retirement accounts, or other investments. In a stagnant wage environment, the drop in oil prices may be the first real raise millions of workers have seen in years. For those who have not yet retired, it is a good opportunity to invest in oil companies while the stock is cheaper, while those who are already retired should hold off on selling their shares for possibly a few years until the price of crude makes a recovery. And it will recover. So try not to do what some people are doing by buying a vehicle that uses more gas than you need.