Falling gasoline prices have motorists pleased at the pump. But why are these price decreases happening and what are the short-term and long-term implications for the economy, alternative energies and consumers’ spending habits? Three University of Michigan-Flint energy experts discuss and analyze the factors and consequences behind the decreasing crude oil prices and U.S. gasoline prices.
Derwin Munroe, a lecturer IV in Political Science, teaches a course in international relations and a course in global energy. Associate economics professor Christopher Douglas teaches a course in international economics and does research on energy prices. He is chair of the Economics Department. Seung-Jin Lee is an assistant professor in sustainability and mechanical engineering and is part of both Earth and Resource Science and Department of Computer Science, Engineering & Physics. He conducts research on electric vehicles.
Why are these low oil and gasoline prices happening and why are they happening now?
Munroe: Global oil prices, as well as U.S. gasoline prices, have been falling for the last six months. And there are some different explanations for it or different components of a broader explanation. One of them is increased U.S. production from domestic sources. There has also been an expansion, or at least a reduction to cut production by major exporters at the global level. There are some other components of the price decline over the past eight or nine months, which include the impact of greater efficiency in the U.S economy and global economy very broadly but also there is some speculation or some evidence that there has been a downturn of the economy and the demand has not kept up with production or the expansion supply over time and that has led to the decline in prices.
Douglas: What you are seeing is both an increase of supply both from nontraditional sources of oil, the U.S. in particular, Texas and North Dakota, oil in oil shale, which previously was impossible to get to. New technological innovations have made that oil now possible. Also you are seeing the Saudis increase oil production very aggressively to protect their market share in the face of OPEC overproduction. So there is an increase in supply. Demand worldwide is falling. In particular, the economy of Western Europe is slowing down. And if you look at who is responsible for the rise in the oil consumption the last for the ten years, it is the demand from India and China. There is some evidence the Chinese economy is slowing down or slightly under performing expectations. It is always hard to know for sure, what is coming out of China, given how secretive their economic statistics are.
But if there was a broader economic slowdown in China that certainly would have a decrease in oil demand, which would cause oil prices to fall. If you look at oil consumption for the developed countries over the last ten years, right now oil consumption is lower than it was in 2005. So worldwide oil demand is being driven by these developing economies.
Lee: It is basically an issue of supply and demand. That’s how oil has been throughout history. And because of all the economies working the way they are, especially the weaker economy in China and Western Europe, and Russia being an issue as well, with their sanctions being in place, that also effects the situation. And the stronger dollar, that has also helped in reducing global gas prices. Oil and gas is a separate issue, but overall it has become a supply and demand issue.
What are the economic implications if the low prices continue for an extended period of time?
Munroe: The macroeconomic consequences of the global oil price decline and the U.S. price decline are mixed. On the one hand, it is positive. Lower oil prices are good for developing countries that are net importers. It is also good for the long-run goal of environmental conservation. For some extent, it is also good for U.S. consumers. But on the other hand, it is negative for reviving the global economy. Japan is concerned, for instance, it will undermine its attempt to reflate its economy.
There is also an impact it may have on the long-term desire of developed and developing countries to diversity their sources of economy. So there has been some speculation that these low oil prices will make investment in new areas of energy less profitable. And so it will actually hold back or slow down the long-term goal of finding alternative sources or financing alternative sources.
Douglas: Lower oil prices are traditionally called a favorable macroeconomic shock or favorable supply shock, which means that at net, they are good for the U.S., because the U.S. is a net oil importer. It is a little more mixed now because if you look at the source of job creation following the 2008 recession, creation in the oil and gas sectors has outpaced job creation in the broader economy. And these jobs tend to be higher paying blue collar jobs, the types of jobs the economy has struggled to create in the past. If job growth in that sector slows down with falling oil prices making oil in shale formations not profitable to extract anymore, those workers are going to struggle to find comparable work in other sectors. But because the U.S. is a net oil importer, I think on net the benefits of lower oil prices to the consumers outweigh the costs to workers that are displaced in the oil producing sector.
In terms of other countries, oil exporting countries, members of OPEC, Russia and so forth, falling oil prices is unambiguously bad. Those countries took huge bets on whatever it made it expensive. All those countries are counting on oil being more than 100 bucks a barrel to balance their budgets. Russia in particular needs oil to be above $100 per barrel. OPEC, on average, needs oil to be above $110 per barrel. So right now oil is about half or less of what those countries need in order to break even. There are countries that are in worse shape. Venezuela, for instance, exports a type of oil that is very hard to refine. It has a high sulfur content and it is very heavy. It is like molasses almost. The energy content is just not very good. And the Venezuelan economy is a disaster anyway, following the disaster in my view of the presidency of Hugo Chavez. They are counting on oil being above 160 bucks per barrel. So that economy is in big time trouble. So I think the short answer is overall lower oil prices are good for the U.S. consumer and bad for all the countries that export oil.
Lee: There are several stakeholders here when it comes to oil prices. There is the average U.S. consumer. There are the oil companies. There are the oil producing states…the sustainability of the environment is a big issue when it comes to energy. The average consumer would definitely benefit, at least in the short term.
Two key words here. Inflation and deflation. And we are definitely seeing deflation right now due to lower gas prices. Transportation is much cheaper and people feel the need to be more competitive with lower prices. Already in Flint for example, you recently saw very low gas prices and then it bumped up momentarily, and that was due to, they were kind of bottoming out their profits. Because they were over-competing with each other. Overall though, over the long-term, if this continues to be the case, inflation might hurt the consumer a little bit but deflation is detrimental to the overall economy because the overall economy is not profiting. It is a good chance to, a reason, it is an opportunity to increase the gas tax. It has not been increased over 20 years now. Although that is not going too well, even when gas prices are so low, and that’s also something else because it relates to externalities and also it is not a good incentive right now, with lower gas prices, it is not a good incentive for the overall population to be more interested in renewable energy sources. That is a side effect which I am concerned about.
Munroe: Lower gas prices in the short run will mean there will be less of a revenue flow from gas taxes that go into the pool for highway construction and highway maintenance at the state and federal level. So it will have an impact in the short run in terms of that revenue source. Over the long run, it may lead to increased consumption and it might balance out in the net. But if we predict these oil prices will not stay low, at this level, for an extended period, then the short term impact is going to be just negative on the revenue side.
At the global level, the developing countries are also looking at a fiscal impact. Venezuela is a very severe case. But a number of other oil exporters, Nigeria for instance recently had to recalculate its budget based on these lower oil prices and the projection of lower oil prices. Indonesia is also affected by these lower prices. And that had a spillover impact on financial markets and on the spot market for oil in the long run and medium turn. So there is some build-up of some worry in the markets about the impact of these oil prices, whether they prevail over a long period of time or whether they are going to have just a severe impact in the short run on a few states.
Douglas: I think when we think about gas taxes, we have to be careful about what gas taxes we think about. There are a couple kinds of tax. There is a tax which is a flat cents per gallon tax. Every time you buy a gallon of gas in the state of Michigan, you pay a 19 cents per gallon tax so it is 19 cents regardless of what the price of a gallon is. So if people are buying more gas because the prices are lower, you might actually be getting more gas tax revenue. But if the gas tax is a percent of the sales price, which Michigan is considering switching over to, to tax gas as a percent of the wholesale price, so if the wholesale price comes down, you perversely would collect less gas tax revenue.
So really it depends on how the gas tax is structured, whether tax revenues would go up or down as prices change. The state of Michigan is a little bit behind the eight ball because prices rose over the last ten years. They missed out on those prices rising because the tax was a flat cent per gallon. They now are switching over to, perhaps, the percentage based tax and now they are doing that at the wrong time with prices trafficking back down. So unfortunately the state of Michigan kind of is moving in the opposite directions about how to collect more tax revenue as gas prices change.
Do the lower prices potentially change consumers’ mindsets or behaviors and are there any implications stemming from these potential changes?
Munroe: It is going to have a positive impact on the pocket book in almost an immediate and instantaneous time frame. Depending on the amount of gasoline that is consumed by the individual or household, it might have a short term savings. But insofar as we are in the middle of winter and it may have some kind of a longer series of cause and effect relationships to heating costs than we would have to be much more wary of thinking of the positives.
Electricity costs and heating natural gas prices are not as directly tied to gasoline prices so there is some, perhaps, hesitancy on the part of consumers to change their consumer patterns based on these lower gasoline prices. I believe there have been some surveys that have been conducted which show that consumer confidence has gone up because of these lower prices but I haven’t seen any evidence there has been any change to consumption patterns by households or individuals based on these lower prices. Now this might change if the prices keep at the fifty dollar global price per barrel over a longer period of time but economists are actually predicting that by the summer, prices will actually go back up a bit once the market equilibrates. So there is some speculation that there is likely to be a return to prices over fifty dollars a barrel so consumers are a little savvy about that.
Douglas: Immediately, the fall of gas prices will leave consumers with more money in their pocket, which they can spend on other goods and services, which helps retail sales, which have struggled in the economic recovery, so that’s a good thing. The question is how do consumer expectations adjust to falling gas prices? Do consumers think that gas prices will remain low forever or do consumers think that prices are low just as kind of as a one-time blip?
My view is that consumers’ expectations take a long time to adjust. That consumers have seen 10 years plus of rising gas prices. One or two months of falling gas prices isn’t going to readjust the expectations. So I think consumers are going to be very hesitant to say ‘Oh gas prices are low, let’s go back out and buy a big SUV or gas prices are low, let’s go buy a huge house 50 miles from work because the commute is so cheap.’ I don’t think you are going to see those expectations change on a dime and even if they did, those type of behaviors just take a long time to materialize. It takes a long time for a consumer to say, go buy a brand new car or go buy a new house. Those are not decisions that are made on a whim. So I think in the short term, or even in the medium term, you don’t see a whole lot of changes in consumer behavior in response to falling gas prices, other than they have more money to spend on other stuff.
Lee: Overall, you got the message that consumer confidence is going to rise with lower gas prices. Related to that, consumers have very short term memories. It was the first time since 2010 maybe where the average fuel economy of new car purchases have actually gone down over the course of a few months. And that is primarily because more people are actually buying more SUVs, they are less focused on the Priuses and Volts and EVs (electric vehicles) for example. Prius is one example. The gas prices is effecting lower purchases but it also is at the end of its product life cycle. Just like any other car when it’s at the end of its model year, it is up for a new design. So that’s another reason why it’s happening.
Overall, consumer confidence is going up, however there are also externalities. For example, there is a study where lower gas prices increases road fatalities, increases more road congestion, because it’s kind of like a rebound effect. It is kind of like a side effect. When you have energy efficiency appliances for example, you tend to use more of it. If you are eating low fat foods, you think you are losing weight by eating low fat foods then you may think ‘Oh I’m losing weight so I can eat more of that food because I’m doing good for my body.’ It is the same thing with gas prices. Since I am saving money, maybe I can drive more. If people tend to drive more, then you have more cars on the road, more chance of fatalities, more congestion and so that is kind of a side effect and how it is effecting the average consumer in general.
How does the price change affect small businesses?
Munroe: Small businesses will benefit from lower gas prices insofar as they have as part of their cost profile gasoline prices for transportation or the upstream costs of moving or distributing their products but my experience with small business people is that they are very cautious about making long-term investment decisions based on short term things like gasoline price fluctuations. If the small business is in some way in a position to make a longer term investment change based on their position in regards to energy use then they probably will have made that regardless of gasoline prices. So I think small businesses will benefit in the short term by having increased savings but I don’t think it will change their investment or profitability over the immediate or long-term.
Douglas: A lot of small businesses like landscaping companies are dependent on the price of gas so they will see a burst of profitability due to lower costs. Small businesses, in general benefit. The fact that energy costs fall, oil, natural gas and so forth. And small businesses will benefit too when consumers realize the savings from lower energy prices and are able to use those savings to buy things that small businesses are selling.
Lee: It is helping small business in general. However, when you think about it on a larger scale, it also depends on how big your firms are and it’s true, if this continues to be the case, if there are investments that are made and they can’t recoup these investments with prolonged lower gas prices, that might hurt them down the road but for now it is benefiting small businesses in general.
Does the price reduction have any impact on alternative energies?
Lee: Alternative energy, renewable energy in general, there are people that have opinions across the board. I personally believe it is something we need to definitely invest in. Oil prices do not have a direct correlation with alternative energy because most renewable energy is produced using electricity, when you are talking about solar and wind. When you think about it, when we are trying to achieve sustainability, in terms of reducing greenhouse gas emissions for example, if you are familiar with the intergovernmental panel on climate change, they release synthesis reports every few years and the fifth report recently told about (fossil fuels without carbon capture should be phased out by the year 2100 to avoid irreversible climate change). We can care about all we can about the economy, but when we think about greenhouse gas emissions and how it’s detrimental to the Earth, that’s something we need to be concerned about.
This is why it is so hard to get out of this cycle of consuming oil. We are an oil hungry world actually, not just the U.S. but overall. So in order to get out this cycle of consuming oil we definitely need to find a way that hopefully incentivizes not just consumers but governments and companies to find alternative ways of consuming energy and producing energy. This in a way, doesn’t help, but fortunately it is not directly correlated because there is still a lot of interest in solar and wind. Because it is something we need to take care of, because fossil fuels are not an infinite resource.
Related to that, I’m a big fan of electric vehicles and the reason why is it’s kind of like killing two birds with one stone. Once you produce electricity in a cleaner fashion, then you are also not only producing electricity in a cleaner way but you are also fueling the transportation infrastructure. In that way, by producing clean energy, you are benefiting not just transportation but also the electricity grid, which are the two biggest energy consumers and greenhouse gas emitters.
Douglas: I don’t really think lower energy prices do anything in short to medium run in terms of renewable energy development. In my view, there are no real renewable energy sources out there that are ready to be rolled out on a broad scale. I think we still are in the research and development stage for renewable energies. I think solar is promising. We just need to get the cost of solar down, make solar storable so you can have electricity when it is not sunny. Make the solar panels more efficient and so forth. I’m optimistic about that for the long-term. I think we will figure out how to harvest all the free energy from the sun. We just don’t know how to do it yet.
I don’t really think there is anyone out there that seriously thinks that oil will remain below fifty bucks a barrel forever. I think most people out there think this is maybe a one or two year thing. Unless the economies of China and India completely implode forever, since they are the ones that have been driving worldwide demand for the last ten years. Oil consumption by the developed countries, including the U.S., has fallen since 2005 as the U.S. economy has become more energy efficient. As a consequence of higher oil prices that gives people incentive to cut back, conserve and so forth. So overall, I’m pretty optimistic about alternative energy. I don’t think anyone stops researching alternative energy because of this temporary decrease in oil prices. Perhaps people are less likely to use alternative energy right now but I don’t think alternative energy is ready to be used right now on an economically efficient scale.
Munroe: I agree that the research and development side of alternative energy has been very much affected by the long term rise in gasoline prices and oil prices. Strangely enough, one hundred dollar a gallon barrel costs for oil actually was positive for alternative energy investment and research and development. And depending on how long these lower prices prevail, there will also be a backlash of negative consequence on investment or any new technologies.
I agree there has been much more investment and the lowering of the costs of, particularly solar, in the world economy. And that was primarily driven over the last five to eight years by investment by China, or firms in China, in new, lower cost solar panels. With the slowing down of the Chinese economy and lower gas prices, one wonders how profitable those firms will be in the long or medium term. There is also some belief that this low oil price will have an impact on other, more traditional forms of energy extraction. So fracking in the U.S., new higher cost or higher risk oil fields for instance, the big oil field that was discovered in the last five years off Brazil. There are real questions now about that field’s profitability and whether that is going to continue to have an impact. So the alternative energy industry and its profitability is closely tied to the fossil fuel energy supply. And it is unclear how lower oil prices even over the short term, a year or two year period, whether that will have an impact on the longer term need for alternative energy source to replace the hydrocarbon based economy.
Munroe: I think that the low oil prices will have an impact on politics, both in the U.S. and globally, even if it is for a short-term, one year, or even a shorter time period. We already hear, within the U.S., voices that the oil prices will have an impact on investment decisions, Keystone XL comes to mind. It will also have an impact on a long-term challenge for oil companies in the U.S., or what is perceived as a challenge or a problem. The U.S., since the 1970s, has had an export ban, even though the U.S. has been a major oil producer for much of the 20th century. Since the 1970s, the U.S., by law, has been prevented from exporting oil. Lower oil prices returns to the agenda the question of whether the U.S. government should have this ban in place. Oil producing states and their legislators and firms are pushing for a repeal of the ban. There are some political dynamics that are going to come out of the even short-term lowering of oil prices.
At the global level, there is a very significant impact of low oil prices. It destabilizes some very fragile and potentially volatile places, like Iraq and Saudi Arabia. There is already an interconnection between the lower oil prices and Russia’s conduct at the international level. There is likely to be an international dynamic that flows from these prices. Long term, a decline in the oil prices has an impact on political stability at the global level.
The other side of the coin, strangely enough, is that even a very brief period of political instability at the international level could have a very sharp reversal effect on gasoline prices and oil prices. So all it would take is perhaps a ramping up of tension between Iran and its neighbors or Russia becomes more aggressive next spring or summer and oil prices are back to close to one hundred dollars. So these lower oil prices are very subject to political instability or political effects.
Douglas: There are some pretty broad international repercussions for low oil prices and I don’t view those as altogether negative. I think it destabilizes some countries that at least I wouldn’t mind seeing destabilized. Venezuela, for instance, has a terrible economy and a very repressive government. It wouldn’t be too bad in my view to put some pressure on that government to try to liberalize the economy a little bit and reduce the rate of inflation, reduce the price controls and so forth. Same with the Russian government. It seems like Vladimer Putin, to me at least, is an international menace so having some low oil prices for the next couple years and slowly bankrupting that government, to me, doesn’t seem like a bad thing.
With Iran, I don’t think there is a huge risk that Iran becomes aggressive with its neighbors given that their economy is basically a disaster right now with double digit or triple digit inflation, double digit unemployment, widespread discontent so perhaps the low oil prices will put some pressure on the Iranian government, which is just a brutal, repressive government, which would help, perhaps, usher in a more benevolent government that respects human rights. When you look at oil producing nations, I think that most people tolerate them because they produce something that we need. But altogether most people wouldn’t be too upset if we saw them disappear and perhaps be replaced with something better. So to me, I’m a little optimistic that low oil prices put some pressure on some people I wouldn’t mind seeing some pressure being applied to.
Lee: I am very optimistic about how our transportation infrastructure is going to change, including in Michigan. A lot of big cities in this country are redesigning their cities, such that they are more sustainable, in general, so they are more dense, people need to travel less. Nobody likes to drive intentionally. We don’t drive because we love driving. We drive because we need to get to work. We need to go places we want to go to. I think gas prices by themselves will not change how people behave, in terms of their driving behaviors.
Overall, I think Michigan does have a lot of work to do, in that sense, in that it is a very auto dependent state, even the cities of Detroit and Flint, a lot of people drive, there is very limited public transportation going on. We definitely need to redesign our cities such that they are more dense, they are more walkable, and people will rely less on gas overall. And that way, people are more healthy, they get to access more of their community and overall it is better for the environment. That is something I am very passionate about. For example, I am doing research on electric vehicles, how EVs can be adopted and whether that would be a good thing in terms of energy and environmental impacts. Because there are a lot of unknowns about electric vehicles at the moment, in terms of production. There are a lot of negative effects of producing EVs in terms of battery production. That is just one example some of the negative consequences of using electric vehicles. So by establishing and kind of incentivizing that kind of research and investment, we can hopefully not stay on the track of consuming more oil and gas and try and find more alternative ways of using energy.
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