Oil Prices: Why? So? Then What?

Dr. Nyakundi M. Michieka

Assistant Professor in Economics at CSUB

Introduction
In this article, the effect of oil prices on various economies is outlined. In June 2014, the
spot price of West Texas Intermediate (WTI) was $105.79; by December 2015, the price was
$37.21 (Figure 1). (U.S. Energy Information Administration 2016). This 70 percent drop in oil
prices over 18 months has implications for regional and global economies. Oil importing countries,
such as U.S., Japan, China, and India, are set to gain; exporting countries, like Saudi Arabia,
Russia, Canada and United Arab Emirates, are set to lose (Brown and Ycel 2013, CIA 2016, U.S.
Energy Information Administration 2016).

Figure 1: Monthly Spot Prices for WTI

Why are oil prices low?

There are many answers to this complex question. Supply: when the supply of oil increases,
oil prices decrease. There are a number of reasons why oil supply has gone up. The increase of
U.S. shale oil production catapulted the U.S. to become the worlds largest oil producer (Figure
2). Subsequently, Saudi Arabian, Nigerian, and Algerian oil that was once sold to the U.S. needed
to find another home, forcing producers to cut prices to reduce inventory. In addition, Canadian
oil production and exports increased, while Libya and Iraq maintained higher than anticipated
production levels, despite their ongoing conflicts. At the same time, demand for oil has declined
due to the appreciation of the dollar and increasing energy efficiency, putting additional downward
pressure on the price of oil (Krauss 2016).
 Figure 2: 2014 U.S. and other top 5, total petroleum and other liquids production

Effect on Economies
According to Murphy et al. (2015), a 50 percent decline in oil prices causes a 0.3 to 1
percent increase in U.S. GDP, depending on which economic model is used. With low oil prices,
overall economic activity in the U.S. is set to gain, although oil producing states will be negatively
affected. Today, Alaska, Louisiana and New Mexico are facing distressed budget situations due to
the low oil prices, according to a report by Standard & Poor's Ratings Services (Petek and Perry
2016). Outside the U.S., the Russian, Venezuelan and Nigerian economies are facing similarly
strained budgets (Tuzova and Qayum 2016).

What about employment?

The drop in oil prices have had a significant effect on employment, regionally and
worldwide. Royal Dutch Shell cut 7,500 jobs in 2015, while BP will eliminate 4,000 jobs in
addition to the 4,000 it cut in 2015 (Reed 2016). Chevrons CEO announced plans to cut 6,000 to
7,000 of its employees (Scheyder 2016), while Schlumberger, Baker Hughes and Halliburton
slashed 46,000 U.S. jobs (Egan 2015). Overall, an estimated 250,000 jobs have been lost globally
since the beginning of the long price decline (Reed 2016). At the state level, a study by Brown and
Yucel (2013) reported that a 50 percent drop in oil prices reduces employment in Wyoming,
Oklahoma and North Dakota by 4.3, 2.3 and 2.0 percent, respectively. Here in Kern County, the
last 18 months have been accompanied by increased farm employment while the oil and gas
industry cut jobs. Overall employment, however, increased during this period (Michieka and
Gearhart 2016).

Looking ahead
On January 25th, 2016, the spot price of WTI was $30.31. Predicting the direction in which
oil prices are headed is a complicated affair, as many factors are involved. Nonetheless, it is
important to note the following events set to take place in the short, medium, and long term: (1)
There are reports that Russia is willing to work with Saudi Arabia on the possibility of cutting
production of crude oil, which may reduce supply and raise prices; (2) On January 16, 2016,
sanctions were lifted on Iran meaning that the country with the fourth largest reserves of crude oil
is set to increase oil exports; and (3) A number of African countries have discovered large amounts
of crude oil reserves and could start production in the long run and possibly export much more oil,
further depressing prices (Essandoh-Yeddu and Yalamova 2016).

References
Brown, S. P. A. and M. K. Ycel (2013). The Shale Gas and Tight Oil Boom: U.S. States
Economic Gains and Vulnerabilities. Energy Brief. C. o. F. Relations. Council on Foreign
Relations.
CIA (2016). "Country Comparison: Crude Oil-Exports." Retrieved January 2016, 2016, from
https://www.cia.gov/library/publications/the-world-factbook/rankorder/2242rank.html.
Egan, M. (2015). Oil crash cut my pay and killed over 86,000 jobs. CNN Money. CNN Money.
Essandoh-Yeddu, J. and R. Yalamova (2016). Current Drop in Oil Prices: Impact on Africa. IAEE
Energy Forum International Association for Energy Economics. Fourth Quarter 2015.
Krauss, C. (2016). Oil Prices Decline More Than 5 Percent as Stockpiles Increase The New York
Times, The New York Times.
Michieka, N. M. and R. S. Gearhart (2016). An Empirical Investigation of the Effects of Changes
in Oil Prices on Employment in Various Sectors of Kern County. C. S. U. Bakersfield.
Working Paper.
Murphy, A., et al. (2015). Plunging Oil Prices: A Boost for the U.S. Economy, a Jolt for Texas.
Economic Letter. Dallas, Texas, Federal Reserve Bank of Dallas. 10: 4.
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New York Times.
Scheyder, E. (2016). Chevron slashes jobs and spending to weather low oil prices. Reuters.
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Tuzova, Y. and F. Qayum (2016). "Global oil glut and sanctions: The impact on Putins Russia."
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U.S. Energy Information Administration (2016). Spot Prices (Crude Oil in Dollars per Barrel,
Products in Dollars per Gallon). U.S. Energy Information Administration.