May 18, 2015
My name is Laurel Graefe, and I'm a director here at the Federal Reserve Bank of Atlanta for the regional economic information network. My job is to incorporate grassroots economic information into policy conversations.
What happened to oil prices over the past year?
Between mid-2014 and early 2015, crude oil prices declined by more than 50 percent, and I think it was something that even the most prudent of analysts wouldn't have been able to expect the magnitude or the speed at which prices declined. It really was due to a number of factors. It's hard to pinpoint just one that was responsible for the decline. On the demand side, we've seen disappointing global growth, both coming from European economies and also emerging markets that have helped to dampen a bit of demand coming from those areas, as well as ongoing investments in energy efficiency that have continued to decrease the energy intensity of global GDP. It's about half what it was in 1970. So on the demand side, we're seeing quite a bit lower expectations for the progress of demand growth over time.
But I would say probably even a larger impact is coming from the supply side, where the landscape has totally shifted over the past few years, largely as a result of technology investment. Fracking technology, horizontal drilling, other types of advancements that have allowed, particularly in the U.S., producers to access tight oil, have really shifted the global balance of oil. Not only consistently have we seen tight oil production outpace expectations since 2011 every single year, we also have seen forecasts for future production to increase as well, and I would say that shifted landscape, along with the failure of OPEC to pass reductions in production limits, really helped to dampen oil prices recently.
What is the outlook for oil prices?
Oil prices are one of those things that tend to be notoriously difficult to forecast, partially because there are so many factors that can impact the path of growth. On the one hand, there are the policy reasons. So, whether it's oil cartel policies, environmental inclinement policies, or other geopolitical issues, politics has the potential to have an enormous impact on oil prices. Economics, of course—the pace of global growth, whether it accelerates or decelerates—can impact the pace of demand growth for oil. And then there's of course the influence of technology, where technology can both impact efficiency of oil consumption on the consumer goods and manufacturing side of things, and also has the ability to open up new resources. As drilling and production technology improves, it can really increase what is considered to be the supply of oil nationally and globally.
Additionally, I would say climate can play a big factor in oil prices just because the number of heating and cooling days and driving days can have a big impact on the amount of oil that is consumed worldwide, and that can have an influence on prices. Then of course geology and expectations—there are so many things that play a role that even the most sophisticated models can really struggle to pinpoint an exact path of oil prices, even going out over a relatively short period of time.
I would say of the forecasts out there, futures prices tend to be about as good of an indicator as anything. Right now, futures markets are putting oil prices by the end of this year between 60 and 70 dollars a barrel—which, again, can be useful when thinking about the future, but I have to remind you that the confidence bands around this forecast are exceptionally large. It can be useful to think about the different factors impacting oil prices but difficult to pin down an exact price because the factors vary so widely.
What do lower prices mean for economic growth?
The U.S. is both a major producer and a major consumer of oil, so the impact of lower prices can have varying impacts on different portions of the economy. On the production side, lower prices can really hurt the economics of some of the more capital-intensive production projects going on in the U.S. So we've already seen announcements of major layoffs as well as postponement and cancellations of investment projects in future oil exploration and production, and that certainly has already shown up in economic growth here in the U.S., where business investment and structures took away about three-quarters of a percentage point from GDP growth in the first quarter, almost entirely due to declines in investment in the oil and gas industry.
But the economic impacts of lower oil prices are certainly not a zero sum game, where we're seeing dramatic margin improvements as input costs are lower from the other side of the economy, where we have downstream users of oil for transportation or for other manufacturing inputs. [They] are really benefiting from this lower oil price scenario. That seems to be helping to feed into consumers as well, where lower gasoline prices have helped to boost consumer sentiment significantly. We recently saw the strongest sentiment reading since before the recession. I suspect gasoline prices are playing a very large role as well in improved savings rates, improved real wealth, and other measures of consumer well-being. It seems like one of the conundrums right now is that we haven't seen this increased savings pass through into spending so far. However, there does seem to be reason to believe that this may end up showing up in stronger consumer numbers as the year progresses.
How are oil prices affecting inflation?
Lower oil prices toward the beginning of the year really pulled down headline inflation considerably. We saw actual outright declines in headline consumer price indices. Toward the beginning of the year, however, I think it's important to keep in mind that inflation is determined not by actual price levels but by changes in prices. So even if oil prices stay low, as long as they don't continue to decline, their influence on inflation should level out.