Surging Oil Prices on the U S Economy Essay

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Surging Oil Prices on the U.S. Economy

Although the lingering effects of the Great Recession of 2007-2009 continue to dissipate and economic growth resumes, volatile global oil prices remain a source of concern for economists and consumers alike. While the experts debate the precise date at which peak oil will be reached and the search for alternative energy sources has assumed new importance and relevance, it is clear that the world's commercial infrastructure will depend on fossil fuels well into the foreseeable future. Indeed, some authorities caution that unless drastic steps are taken today, the world will deplete its fossil fuel resources long before commercially viable alternatives become available. In this environment, determining how surging oil prices affect the U.S. economy represents a timely and valuable enterprise. To this end, this paper provides a review of the relevant peer-reviewed and scholarly literature to determine the impact of surging oil prices on the U.S. economy, followed by a summary of the research and important findings in the conclusion.

Review and Discussion

The past decade has been characterized by a high degree of volatility in global oil prices, beginning with a significant increase in 1999 that continued to accelerate until 2003, reaching an unprecedented pricing level of $145 a barrel in July 2008 (Ono, 2011). The Great Recession appears to have stunted this acceleration in oil prices, though, at least in part and oil prices began declining in late 2008 until reaching a low of $34 per barrel in February 2009, at which point oil prices started to increase once again (Ono, 2011). According to Ono, "This situation has reinvigorated the debate on the effect of oil prices on the economy" (p. 29). In fact, it would appear intuitive that when the costs of oil increase, other economic measures will be adversely affected and this has consistently been the case in the United States and most other countries as well. For instance, according to Kliesen (2005), the majority of the recessions that have taken place in the United States since the end of World War II were preceded by surging oil prices. Economists suggest that the adverse effects of higher oil prices on gross domestic product growth are attributable to increased production costs and by creating an uncertain investment climate wherein business investments are delayed until oil price volatility subsides (Guo & Kliesen 2005).

Based on their analysis of oil price volatility measures using daily prices of crude oil futures traded on the New York Mercantile Exchange during the period 1984-2004, Guo and Kliesen (2005) found that that volatility of oil prices had a significantly negative impact on future GDP growth as well as other key measures of U.S. macroeconomic performance including fixed investment, consumption, employment, and the unemployment rate. These findings are congruent with a number of other studies that have cited the uncertainty of the global political environment as a precipitating source of oil price increases. In this regard, Ono (2011) reports that, "Many studies have examined the influence of oil prices on the macroeconomy, stimulated especially by dramatic crude oil price increases because of unstable economic and political situations in the Middle East" (p. 30).

One of the more interesting findings to emerge from the Guo and Kliesen (2005) study was that although both channels (i.e., increased production costs and oil price uncertainty) are important, Americans appear to be more comfortable with known price increases than they are with uncertain oil prices, even in those situations where the price may go down. In this regard, Guo and Kleisen conclude that, "This finding means that an increase in the price of crude oil from, say, $40 to $50 per barrel generally matters less than increased uncertainty about the future direction of prices (increased volatility)" (p. 670).

Although increased oil price volatility may be less important than known increases, the harsh reality is that both channels adversely affect the U.S. economy in various and sometimes inexplicable ways. For instance, Casey and Murray (2009) report that during 2007, "Energy costs had a heavy impact on largely energy producing import partners. Import prices from Near East Asia, measured by an index dominated by petroleum prices, rose 35.9%, the biggest increase since 2004" (p. 16). In addition, the increasing quantities of oil that were being imported from Mexico by the United States during this period resulted in a 15.8% increase in prices for all goods imported from Mexico (Casey & Murray, 2009). The volatility of oil prices was also significant during 2007 as geopolitical tensions remained high. As a result of these global economic forces, the costs of oil imports increased by almost 50% in 2007, representing the second-largest yearly increase since 2000 (Casey & Murray, 2009). In fact, the costs of oil have increased significantly every year since 2000 except for a modest decline in 2001 following the terrorist attacks of September 11 but quickly resuming their upward spiral thereafter (Casey & Murray, 2009).

These trends in oil price fluctuation with overall increases have remained consistent for the past several decades. Analysts with the U.S. Department of Energy report that before the oil embargo that took place during 1973 to 1974, for instance, total energy expenditures accounted for 8% of U.S. gross domestic product (GDP), the percentage of oil-related expenditures was slightly less than 5% and natural gas expenditures represented another 1%; however, increasing demand throughout the 1980s resulted in increases in these categories to 14%, 8% and 2%, respectively by 1981 (Earley & Smith, 2011). According to Earley and Smith, "Since that time, the shares have fallen consistently over the last two decades to current levels of about 7% for total energy, while petroleum has fallen even further to 3.5% and natural gas to just over 1%" (2011, para. 2).

More recently, these percentages were less as of 1998 during a period when oil and natural gas prices were lower; however, these metrics have consistently increased in response to higher oil and natural gas prices as depicted in Figure 1 below..

Figure 1. Energy Expenditure Share of the Economy: 1970-2000

Source: Earley & Smith, 2011

The general decline in the energy shares depicted in Figure 1 above is attributable, at least in part, to reduced global oil prices that were in sharp contrast to their 1981 peak; in addition, the consistent decline in energy intensity, measured by energy consumption per dollar of GDP has also declined as a result of structural shifts in the economy and improvements in energy efficiency (Earley & Smith, 2011) as depicted in Figure 2 below.

Figure 2. Energy Consumption Ratio per Dollar of GDP: 1970 -- 2000

Source: Earley & Smith, 2011

Notwithstanding the reductions in the use of oil as a percentage of the overall U.S. economy during the period 1970 through 2000, there has been an increasing reliance on imported oil during the same period of time. For instance, in 1973, net petroleum imports accounted for just 35% of total U.S. consumption; however, by 2000, this share had increased to fully half, and the percentage of imported oil is projected to increase further to almost two-thirds (64%) by 2020 (Earley & Smith, 2011), as depicted in Figure 3 below.

Figure 3. Net Import Share of Petroleum Consumption in U.S.: 1970 -- 2020

Source: Earley & Smith, 2011

Although the U.S. has reduced its use of petroleum as a share of its economy, there is a growing dependence on imported oil. In 1973, net imports of petroleum made up 35% of petroleum product supplied (consumption). For 2000, this share has risen to over 50% and is expected to reach 64% by 2020 (Earley & Smith, 2011). These trends confirm that ceteris paribus, increased energy efficiency is being outpaced by increased reliance on foreign oil sources, a dependency that contributes to a sense of uncertainty on the part of American consumers, business leaders and governmental policymakers alike. Indeed, even federal analysts who are charged with putting the best possible spin on these numbers concede that, "In the past year, forecasters have acknowledged that higher energy prices can become a drag on the overall economy" (Earley & Smith, 2011, para. 3).

Not surprisingly, there have been some mixed results of analyses of the impact of oil prices on the U.S. economy in recent years, with many focusing on how much further damage oil price increases will have on the U.S. economy rather than whether such price increases do in fact adversely affect it. Analysts with the International Monetary Fund for example, report that a $10-a-barrel increase in the price of oil diminishes U.S. GDP growth by 0.5 percentage points (Cohan, 2011). In reality, though, because oil pervades the U.S. economic infrastructure in so many ways, any increase in the price of oil has a multiplier and cascading effect on the economy that is impossible to measure precisely, but which can be extrapolated based on some likely outcomes. For example, some of the most likely outcomes associated with increased oil prices include the following:

1. Airlines are…

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