November 15, 2017

Sky-high oil prices ruined the American economy. In Summer 2005, life looked pretty good for the average American family. The economy was doing well, interest rates and inflation were low, jobs plentiful and gas cheap at $2 a gallon. Then oil prices rocketed, with gas rising to $4 a gallon. That family went from living comfortably to struggling to make ends meet.

For all our focus on irresponsible banks, it was in fact the soaring price of oil – and its impact on household budgets – that pushed America into recession.

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It’s easy, therefore, to assume the corollary is true – low oil prices are good for families. When transport and energy costs are lower, the household budget goes further. Spending goes up, the economy flourishes – all is well. Except, of course, if you’ve lost your well-paid job because it’s no longer economical to drill, not with so many cheap and easy alternative energy sources on the market.

As our dependency on oil decreases, its price becomes less and less relevant. Right now, oil is a pocketbook issue, but if the trend for alternatives ratchets in pace, that may well change.

An oil worker fills underground tanks at a Texas gas station. Sky-high oil prices had a devastating impact on family budgets, triggering the Great Recession. Credit: Paul Moseley/Fort Worth Star-Telegram/TNS/Sipa USA)

Sky-high oil prices hit low and middle-income families hard

Based on the historical relationship between oil price and GDP, economist James Hamilton says that the Great Recession was predictable.1 Well, it would have been if we’d known what was going to happen to the price of oil. It was the collapse in auto sales and subsequent fall in employment in auto-related manufacturing, precipitated by sky-high oil prices, that triggered the recession – without the oil shock, Hamiliton says, we’d be talking about slow growth.

‘But it was the housing bubble that led to the crash, which in turn led to the recession’, you might reasonably say. Certainly, housing was a contributing factor. But housing had already been acting as a “significant drag”2 on the economy.

It was excessively high oil prices that explain why, in 2007, house prices in US metropolitan areas saw big drops in zip codes with long commutes, but modest increases in those closest to city centres. When gas is expensive, distance to work matters, with families being forced to choose between filling the tank or paying the mortgage – tellingly, foreclosure rates increased as distance from urban centres increased.3 Derek Thompson, writing in the Atlantic, points out that as oil prices started to increase from 2005, house building decreased. 4

This sensitivity to oil price is hardly surprising: the most popular vehicle in America is a truck – the Ford F-Series to get specific – which takes around 27 gallons of petrol. When the price of gas doubled, filling the tank went from around $50 to more than $100. You don’t have to be living on a shoe-string for that to devastate the family budget.

Every one-penny reduction in gas prices puts more than $1 billion a year into the hands of consumers for them to save or to spend on other things. So, that $1.50 reduction in the price at the pump has been a $150 billion a year stimulus plan. Stephen Moore, Wall Street Journal

Low oil prices are a boon to consumers

Lower prices, on the other hand, means cheaper transport and energy costs, and that means more money in the pockets of consumers. Stephen Moore, writing for the Wall Street Journal, provides a “rule of thumb” for what that means in economic terms.

“Every one-penny reduction in gas prices puts more than $1 billion a year into the hands of consumers for them to save or to spend on other things. So, that $1.50 reduction in the price at the pump has been a $150 billion a year stimulus plan.”5

A family with dollars to spare, might treat the kids to a trip to the cinema, or buy those new trainers. They might deposit a little more in their 401k, or the family savings account (which is then invested). According to Oxford Economics, a $20 fall in the price of oil provides a 0.4% boost to global growth within a three-year period.6 And while GDP is a flawed measure when it comes to assessing standard of living, expansion is undoubtedly better than contraction.

So the lower the oil price the better… Except, of course, that families are not just consumers, they’re also workers.

In Texas, the collapse in the oil price led to the loss of a third of jobs in the oil and gas sector. Cheap petrol is little consolation for unemployment. Credit: Joshua Doubek via Wikimedia Common

What if your job depends on the oil industry?

Rock-bottom oil prices don’t look so good if your livelihood depends on the industry. In Texas, it is estimated that a third of jobs in the oil and gas sector were lost as a result of the price collapse. In the UK, the number of people employed in the North Sea energy sector plunged from almost half a million before the price collapse to 315,000 by the end of 2016, and the sector has continued to shed jobs in 2017.7

In Houston –America’s oil capital – more than 77,000 people working in oil-related jobs have been handed pink slips. For those who haven’t moved into alternative jobs, lower household transport and energy costs are no compensation for unemployment. Analysis by the University of Houston’s Bauer College of Business illustrates the vulnerability of an economy so dependent on oil:8

“The strong growth from 2011-2014 demonstrates the power of the fracking boom; it is equally remarkable how quickly employment growth ended after oil prices collapsed in late 2014… The current estimate of job gains in the oil and gas sector for 2017 is 7,100 jobs, or about 9 percent of the 77,200 jobs that were lost to the oil bust.”

Or as Richard Parker writing in The New York Times in September put it: “The tale of the Texas Miracle was a big fat lie: Plentiful oil, low regulation and even lower taxes are not a panacea.”9 If oil prices were to plummet to anywhere near $10 a barrel, even the vastly cheaper, technology-enabled fracking would be uneconomical – and legislators in oil-dependent regions would need to radically overhaul their economic model.

Algorithms and robotics have already replaced many roles, and technology is advancing at pace. Drills can be controlled remotely by a technician sitting behind a computer. Drones can be used to inspect equipment.

In fact, even if oil does remain above the break-even price for shale drilling (which, depending on the well and company, can be as low as $3010), government action is still needed.

Those lost jobs are not coming back – or at least not at scale; estimates suggest between a third and half have disappeared for good.11 Earlier this year, for example, The New York Times reported that West Texas producer Pioneer Natural Resources added almost 240 wells in 2016 without adding any additional employees.12

Algorithms and robotics have already replaced many roles, and technology is advancing at pace. Drills can be controlled remotely by a technician sitting behind a computer. Drones can be used to inspect equipment. These technological developments mean the sector needs software specialists and data technicians – and that shift in skills-demand means different types of training.

It also means alternative sectors and jobs need to be nurtured to compensate for the much lower numbers employed in oil-related roles – to avoid the fate of the former manufacturing heartlands that failed to evolve new industries.

Oil-dependent regions could, for example, retain their energy focus, but through industries vying to replace fossil fuel dependency (in 2016 the number of jobs in solar energy surpassed those in oil and natural gas extraction13).

Renewables are playing an increasing role in energy supply as governments seek to reduce their dependency on fossil fuels. If people no longer need oil then the price becomes irrelevant to living standards. Credit: Randy Montoya/Zuma Press/PA Images

Even in oil consuming (rather than producing) regions, the assumption that low prices are good, and high prices are bad is becoming more complicated. The rise of renewables, alongside other demand destroying technology such as electric cars, is changing the terms of the debate.

In Texas, renewables are playing an increasing role in energy supply – if it were a country, the Lone Star State would be the sixth largest wind-power in the world.14 More and more American states are embracing targets for a minimum percentage of retail supply to come from renewables. As for electric cars, an International Monetary Fund paper suggests they will have all but replaced petrol-powered vehicles in OECD nations by the early 2040s.15

If it is a move away from oil that drives plummeting prices, then the standard of living implications will be very different to those resulting from an over-supply. Put simply, if consumers retain a thirst for oil, then low prices help them. But if the demand isn’t there, or is significantly reduced, family budgets may be insulated from price hikes, but they also gain little from price reductions.

As dramatic an impact the oil shock had, in a new world of alternatives, low prices won’t be the boon to families they once were.

  1. James Hamilton, Causes and Consequences of the Oil Shock of 2007–08, Brookings, Spring 2009
  2. Ibid
  3. James Hamilton, Causes and Consequences of the Oil Shock of 2007–08, Brookings, Spring 2009
  4. Derek Thompson, ‘Rick Santorum Is Right: Gas Prices Caused the Great Recession’, The Atlantic, 8 February 2012
  5. .‘Are Low Oil Prices Good for the Economy?’, The Wall Street Journal, 13 November 2016
  6. .‘Winners and losers of oil price plunge’, The Financial Times, 15 December 2014
  7. Adam Vaughan, ‘North Sea oil and gas sector losing thousands of jobs, survey shows’, the Guardian, 6 September 2017
  8. Robert Gilmer, ‘A False Start for Oil Markets in 2017 Means Weak Prospects For Houston’s Economy’, University of Houston, 11 September 2017
  9. Richard Parker, ‘Why Texas is no longer feeling miraculous’, The New York Times, 22 September 2017
  10. Robert Rapier, ‘The Break Even Cost for Shale Oil’, Forbes, 29 February 2016
  11. David Wethe, ‘Robots are Taking Over Oil Rigs’, Bloomberg, 24 January 2017
  12. Clifford Krauss, ‘Texas Oil Fields Rebound From Price Lull, but Jobs Are Left Behind’, The New York Times, 19 February 2017
  13. Anna Hirtenstein, ‘Clean-Energy Jobs Surpass Oil Drilling for First Time in U.S.’, Bloomberg, 25 May 2016
  14. Pilita Clark, ‘The Big Green Bang: how renewable energy became unstoppable’, Financial Times, 18 May 2017
  15. Reda Cherif, Fuad Hasanov, and Aditya Pande, ‘Riding the Energy Transition: Oil Beyond 2040’, IMF, May 2017