The Organization for Petroleum Exporting Countries (OPEC) recently decided to increase production in response to competition from increased global supply, causing a sharp decline in oil prices to just over $50 a barrel from highs over $100. This has caused consumers to rejoice; lower prices at the pump means more money stays in people’s pockets for other expenditures. However, the impacts of lower gas prices on the overall economy are multi-faceted, indirect, unintended, and unpredictable.
Oil giant Halliburton announced on February 10th plans to cut about 7% of its workforce, up to 6,400 workers, in response to rock bottom prices[i]. Several other oil companies over the past few weeks have announced 15-30% reductions in spending. According to the theory that GDP is equal to consumption spending, business investment, and government spending, the decrease in business investment pursuant to lower oil prices must be more than offset by an increase in consumption spending (or government spending but more likely consumption spending) in order for the lower prices to have a positive impact on GDP.
Of course, lower prices in and of themselves directly cause a decrease in consumption spending. The hope is that the decreases in business and consumption spending will be more than offset by business and consumption spending in other industries. In layman’s terms, hopefully people will spend more time going to restaurants and movie theaters because they have more money to spend. It seems likely, however, that some of the money that is saved on gasoline will be saved rather than spent elsewhere. This implies that both business and consumption spending are going to decrease in response to the price cut.
Perhaps the most important development is the weakening of the OPEC cartel, which consists of 12 countries, including Iran, Iraq, Qatar, and Saudi Arabia. Historically, OPEC has controlled an inordinate amount of global oil supply and has used this power to limit production and artificially inflate prices away from equilibrium so as to maximize their profits. In addition to harming consumers in the short term, market structures like this one cause an inefficient allocation of resources. The new normal of low oil prices could have long term benefits in the form of more efficient capital allocation.
The shift may be painful for oil-related businesses as well as their employees, especially in the short term. However, in response to the decline in private sector spending on oil, more can be spent on other businesses in the long run to capture the money consumers previously spent on gasoline. The weakening of a cartel is typically not a bad thing; the long term result here is a global economy operating more efficiently and more closely to equilibrium. Consumers will be more likely to be able to find the products they want, and producers will be more likely to provide them.
[i] Krauss, Clifford. “Halliburton to Trim Its Work Force by 7%.” The New York Times. 11 February 2015. B3.