PBR’s Guide to the Drop in Oil Prices

gasNow that I am home on winter break, I am driving again, which means I am also paying for gas again. On this particular break however, I found myself paying only $2.76 per gallon, probably the lowest price this 19 year old has ever paid for gas. This is quickly becoming one of 2014’s biggest economic stories and will likely remain a big one in 2015.  The Pitt Business Review is here to fill you in on why you are getting a break at the gas pump, and what the effects of this price drop are.

Gas prices are ultimately decided by supply and demand, and right now, supply is high and demand is low. Fracking in the U.S. has lead to dramatic increases in domestic oil production. Other non-OPEC countries such as Canada, Russia, and Libya have also seen significant increases in oil production. This has lead to increases in world oil supply, and has also reduced dependence on OPEC.

Increases in oil production would seem to indicate that positive economic activity leads to cheaper gas prices, but poor economic conditions are also leading to the price reduction. The U.S. has had a relatively successful recovery from the Great Recession, with unemployment currently at 5.9%, per the Bureau of Labor Statistics. However, many other nations have not recovered as strongly; this includes much of Europe and Japan, which are major consumers of energy. When a country is struggling economically, they tend to lower their consumption of oil, lowering demand, which ultimately leads to lower oil prices. So ironically, negative economic conditions can lead to lower oil prices.

Along with increased oil production and economic struggle, fuel efficiency is also a factor in the price drop. In recent years, fuel-efficient vehicles have become more popular among consumers, and with each passing year vehicles are becoming more fuel-efficient. As fuel-efficiency continues to pick up steam, drivers are spending more time between gas stations, which also lowers demand.

Despite all of these factors, OPEC still has the power to raise prices because they can cut production, thereby lowering oil supply. OPEC, however, has decided not to cut production, leaving oil prices at incredible lows. One of the leading theories behind this decision is that they are trying to damage the shale fracking industry. When oil prices become this low, Marcellus shale becomes a less economical choice. As struggling economies recover, gas prices should eventually raise back up, so in the short term, OPEC may be trying to force some fracking companies out of the market.

The current drop in gas prices obviously frees up some income for the individual consumer, but it has some surprisingly negative impacts. A major consequence of the price drop is that it halts progress towards cleaner energy and increased fuel efficiency.

It can be said that we need to save the environment and reduce our dependency on foreign oil, but the consumer trend towards energy-efficient products is mostly lead by the idea that energy efficiency leads to lower costs. With gas prices dropping, fuel-efficiency does not save as much money as it used to.

In the past couple of months, sales for fuel-efficient and hybrid cars such as the Toyota Prius and Chevy Volt have dropped, while sales for SUV’s and pickup trucks have increased. This is significant because of the length of time owners take between car purchases. These are irreversible purchases that will last for over a decade. This is bad for our environment and economy, but is also a terrible mistake for consumers who will pay the consequences for years after gas prices, in all likelihood, rise back to well above $3.00 per gallon.

There are benefits to be had from this price drop, and if prices stay this low for enough time, discretionary spending will increase and likely raise GDP, not to mention make life easier on the individual consumer. However, consumers should be careful to not overreact to this situation, as the cyclical nature of oil prices will eventually cause gas prices to rise again.

Mark Mulkeen







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