Blog Post

Falling Oil Prices and US Economic Activity

Dec 18, 2014 | Stephen P.A. Brown

Figure 1. Lower Oil Prices Will Boost Economic Activity in 42 States
Figure 1. Lower Oil Prices Will Boost Economic Activity in 42 States

Weak demand and abundant supply are behind the recent trend in oil prices, which have fallen by more than $50 per barrel since June. This event is not unprecedented—in fact, the conditions associated with the 2014 crude price drop are very similar to those surrounding a similar drop during 1985 and 1986. In both cases, oil conservation caused prices to decrease while dramatic production gains—then in the North Sea, now in US shale fields—pushed supply much higher than originally anticipated. As a result, the world oil market has reached a new equilibrium that follows a much lower crude price trajectory.

These lower prices will have a range of positive and negative effects that are likely to be unevenly distributed across the United States. I've detailed these in a new RFF issue brief. Here’s a quick guide to the economic impacts we should expect in the coming months:

  • Gas prices and the industry: Crude oil and gasoline prices will fall together, and the reduction in the cost of crude should translate to an approximate $1.25 per gallon reduction in gasoline at the pump for US consumers—$0.85 of which has already occurred. The industry itself will see reduced income, and producers whose production costs are above $60 to $70 per barrel (mostly in new shale fields in Texas and North Dakota) will likely scale back output until prices rise again.
  • Economic activity: The reduction in the price of oil translates to a $116 billion annual increase in disposable income for US consumers, and a net gain of about $920 per household. The overall effect should amount to a one-time increase in US GDP of about 0.7 to 1.0 percent, but these economic effects will be felt unevenly across US states depending on their reliance on the oil and gas industry. Eight states that are dependent on energy production exported to other states will be hurt by lower oil prices, while the economies of 42 states and the District of Columbia will improve (Figure 1).
  • Energy Security: Lower oil prices will make oil extraction less profitable, disproportionately discouraging production in higher-cost regions such as the United States, Canada, and Brazil. As output from these politically stable countries is reduced, US energy security will weaken. At the same time, less stable oil producers such as Russia, Iran, and Venezuela may be less able to oppose US interests as crucial oil income is lost.
  • Environment: Oil consumption reflects oil prices, and the current high supply/low price scenario is expected to increase world oil consumption and increase carbon dioxide emissions. These prices are also expected to influence consumer spending habits as they relate to energy efficiency—reports already suggest that low fuel prices are encouraging people to buy cars that are larger and less fuel efficient than in previous years.

In sum, lower oil prices are expected to help consumers and hinder producers while reducing energy security and increasing pollution. However, despite the current glut in oil supplies, it’s important to remember that oil is a nonrenewable resource—one whose price will still rise moderately over time. This expectation is backed up by the crude oil futures market, where the price is shown as increasing gradually through the end of 2020.