How Oil Prices Impact the U.S. Economy

The extraction of oil and natural gas from shale has reduced the amount of oil the United States needs to import and is adding to the economy in the forms of jobs, investment, and growth. Oil exploration and production is again an important industry in the United States. In this article, we will look at how oil prices impact the U.S. economy.

A Reversal of Fortune

In the 1990s and early 2000s, the United States was struggling under declining domestic oil production and the resulting need to import more oil. Wells in Texas and other regions were still producing, but falling far short of meeting growing energy demands. In the latter half of the 2000s, however, new technology allowed companies to economically draw oil and gas from shale deposits that were once considered depleted because the cost of extraction would be impractical.

Higher prices per barrel of oil also helped to justify the cost of a hydraulically fractured well.The United States is once again one of the top producers of oil and gas. Greater domestic oil production is a net positive for the United States. However, as oil-producing country (and not just an oil consumer), the United States now also feels an unpleasant pinch when oil prices drop.

Oil and the Cost of Doing Business

The price of oil influences the costs of other production and manufacturing across the United States. For example, there is the direct correlation between the cost of gasoline or airplane fuel to the price of transporting goods and people. A drop in fuel prices means lower transport costs and cheaper airline tickets. As many industrial chemicals are refined from oil, lower oil prices benefit the manufacturing sector. Before the resurgence in U.S. oil production, drops in the price of oil were largely viewed as positive because it lowered the price of importing oil and reduced costs for the manufacturing and transport sectors. This reduction of costs could be passed on to consumer. Greater discretionary income for consumer spending can further stimulate the economy. However now that the United States has increased oil production, low oil prices can hurt U.S. oil companies and affect domestic oil industry workers.

Conversely, high oil prices add to the costs of doing business. And these costs are area also ultimately passed on to customers and businesses. Whether it is higher cab fares, more expensive airline tickets, the cost of apples shipped from California, or new furniture shipped from China, high oil prices can result in higher prices for seemingly unrelated products and services.

Job Growth and Investment Dollars

The exploration and production on U.S. shale deposits has been a strong source of job growth. The hydraulically fractured wells tend to have a shorter production life, so there is always new drilling activity to find the next deposit. All this activity requires labor including drilling crews, loader operators, truck drivers, diesel mechanics, and so on. The people working in these areas then support surrounding businesses like hotels, restaurants, and car dealerships. Lower oil prices mean less drilling and exploration activity because most of the new oil driving the economic activity is unconventional and has a higher cost per barrel than conventional source of oil. Less activity can lead to layoffs which can hurt the local businesses that catered to these workers. Therefore, the negative impact will be felt keenly in the shale regions even as some of the positive impacts of lower oil prices start to show in other regions of the United States. This is regionally painful for the country and effects show in state-level unemployment statistics. However these losses may not have a noticeable impact on national unemployment numbers.

The other groups that tends to suffer when U.S. oil prices drop are the banking and investment sectors. There are a lot of different companies drilling and servicing wells on the shale deposits, and many of these companies finance their operations by raising capital and taking on debt. This means that investors and banks both have money to lose if the price of oil drops to where new wells are no longer profitable and the companies dependent on drilling and service then go out of business. Of course, investors and bankers are well-versed in risks and rewards, but the losses still destroy capital when they happen. Between the job losses and the capital losses, a dip in oil prices can trim the growth of the U.S. economy.

The Benefits of Diversity

Even with the loss of growth, the U.S. economy isn’t nearly as tied to the price of oil as some of the other top production nations. The U.S. economy is incredibly diverse. Although oil and gas production has been one driver of recent growth, it is far from the most important sector in the economy. It is, of course, connected to other sectors and losing growth in one can weaken others, but sectors like manufacturing gain more than they lose.

The U.S. economy can take a lot of hits and keep on going because so many sectors contribute to it without any single dominant sector. The same can’t be said about some other oil-producing nations like Russia or Venezuela whose fortunes rise and sink with the price of oil. In short, the U.S. economy has the room to adapt to prolonged periods of high or low oil prices. This means it takes more than just low oil to shake the U.S. economy, but it is not uncommon for oil prices, high or low, to increase the impact of economic shocks.

Bottom Line

Oil prices do have an impact on the U.S. economy, but it goes two ways because of the diversity of industries. High oil prices can drive job creation and investment as it becomes economically viable for oil companies to exploit higher-cost shale oil deposits. However, high oil prices also hit business and consumers with higher transportation and manufacturing costs. Lower oil prices hurt the unconventional oil activity, but benefits manufacturing and other sectors where fuel costs are a primary concern.