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posted on 28 June 2015

Oil Markets Offer Few Easy Answers

by Atlanta Fed

When it comes to energy markets, easy answers are scarce.

Did you think oil prices would plummet nearly 60 percent in late 2014 and early 2015? And why have gasoline prices suddenly shot back up this spring?

Pump prices could have risen lately for numerous reasons, but no simple answers exist. As for the first question, few experts foresaw such a dramatic drop in oil prices because "it's almost impossible to predict," Laurel Graefe, Atlanta Fed Regional Economic Information Network (REIN) director, said at a May 18 presentation.

Speaking at the Atlanta Fed's first ECONversations event held before a live audience, Graefe discussed oil price swings and their effects on the broader economy. A central theme of her remarks: global oil prices are the product of an endlessly complex mix of economic, geopolitical, psychological, and other forces.

History clarifies things

History, however, brings some clarity. For instance, Graefe described similarities between conditions today and a major oil price decline in 1986. In both cases, she explained, increases in oil supplies were an important factor in pushing down prices.

Thirty years ago, energy companies tapped offshore oil fields in Alaska and the North Sea, and Saudi Arabia also increased output. More recently, technological advances such as hydraulic fracturing, or fracking, allowed drillers to reach pockets of oil deep underground in the United States. U.S. oil production soared. The larger supply, coupled with lower demand because of global economic weakness, helped lower oil prices, Graefe said.

When oil prices fall because of changes in supply - and not just slack demand - those declines tend to stick, she noted. Graefe said that after oil prices began falling in the mid-1980s, they didn't surpass their 1986 peak for good until about the year 2000.

Why hasn't consumer spending climbed faster?

Turning to the macroeconomy, oil and gas prices are at the center of an important conundrum. On one hand, falling gasoline prices have put more money in people's pockets and boosted consumer sentiment regarding the economy. Yet overall consumer spending has not grown as much as economic fundamentals suggest it should.

That restraint by consumers is important because consumer spending accounts for about two-thirds of the nation's gross domestic product (GDP) and is critical to economic performance for the rest of 2015, Graefe said, citing a recent speech by Atlanta Fed President Dennis Lockhart.

In another way, falling oil prices already dinged economic growth. During the first quarter of 2015, energy companies spent less on infrastructure, contributing to slower GDP growth.

ECONversations are high-level updates on economic and policy issues and offer the public a chance to talk with Atlanta Fed experts. Previous sessions were webcasts only.

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