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Declining Crude Oil Prices and Its Impact on the U.S. Economy

Published: 20 May 2015 01:05:40 PST

On June 5, 2012, the government reduced its forecast for average gas prices to $3.79 per gallon for the summer driving season, down 16-cents from the initial estimate of $3.95. The Energy Information Administration's (EIA) revised forecast is promising news for the economy; lower gasoline prices will allow many drivers to save money every time they fill up, encouraging more drivers to take their cars on the road this summer.

Part of the reason oil prices have declined during the past month is sluggishness in the global economy, highlighted by uncertainty in the Eurozone and a disappointing U.S. jobs report at the end of May.

The national average for gas is now $3.76 per gallon, according to auto club AAA, Wright Express and Oil Price Information Service. That's 20-cents less than a year ago. The EIA says that gasoline prices should average $3.71 per gallon for all of 2012, down 10 cents from April's estimate. The EIA's forecast for next year is $3.67 per gallon.

Crude oil prices directly affect the cost of gasoline, home heating oil, manufacturing and electric power generation. How much? According to the EIA, 96% of transportation relies on oil, 43% of industrial product, 21% of residential and commercial, and (only) 3% of electric power. However, if oil prices rise, then so does the price of natural gas, which is used to fuel 14% of electric power generation, 73% of residential and commercial, and 39% of industrial production. (Source: EIA, U.S. Primary Energy Consumption by Source and Sector, 2004)

Both consumers and businesses are likely to change their behavior as energy prices change. As we welcome the price relief at the pump, we must remember that any increases in crude oil prices can affect the U.S. economy in numerous ways:
    • Spending Decrease - When the prices of petroleum products increase, consumers have less disposable income to spend on other goods and services. The extra amounts that would have been spent on non-oil-derived products go to foreign and domestic oil producers.
    • Reduced Economic Output - Oil is also a vital input for the production of a wide range of goods and services and it is used for transportation in businesses of all types. Higher oil prices thus increase the cost of inputs; if the cost increases cannot be passed on to consumers, economic inputs such as labor and capital stock may be reallocated. Higher oil prices can cause worker layoffs and the idling of plants, reducing economic output in the short term. 
    • Increased Energy Prices - Higher oil prices cause, to varying degrees, increases in other energy prices. Depending on the ability to substitute other energy sources for petroleum, the price increases can be large and can cause macroeconomic effects similar to the effects of oil price increases.

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