Sensitivity of the U.S. economy to oil prices controlling for domestic production and imports

Highlights

• Risks of large up and down movements in global oil prices remain significant.

• An asymmetric ARDL model is used to evaluate U.S. GDP sensitivity to oil price shocks.

• The analysis controls for important U.S. oil market and macroeconomic variables

• Oil price shocks are found to have significant long-run impacts on the U.S. GDP

• Oil production changes have only significant short-run impacts on the U.S. GDP

Abstract

This paper investigates the sensitivity of U.S. economic performance to oil price changes, accounting for changes in the domestic petroleum supply-demand balance over the last decade. A non-linear (asymmetric) autoregressive distributed lag (NARDL) model is used to estimate the U.S. GDP elasticity with respect to the oil price, controlling for oil production, consumption and imports, and macroeconomic variables. The positive and negative components of the oil price both have statistically significant long-run impacts on the real U.S. GDP. The parameter estimates imply that a 1% positive and permanent oil price shock, all else the same, would have a long-run impact of −0.045% on the U.S. economy (an elasticity of −0.045), but short-run parameters on the positive oil price terms are not significant at the 10% level. The long-run parameter on the negative oil price component term implies an elasticity of −0.034. Thus, controlling for domestic U.S. oil production and oil trade, the long-run oil price elasticity of the U.S. GDP remains within the range of estimates from previous studies. The results also show that domestic oil production and consumption have short-run impacts on the U.S. GDP. The potential extent of interactions among these variables, and implications for the net economic impacts, under an oil price shock are subjects of future research.

Introduction

Declines in U.S. crude oil production dating back to the early 1980s, coupled with increasing petroleum consumption, led to a steady increase in petroleum imports to a peak of nearly 15 MMBD or about 70% of consumption in mid-2006. U.S. crude oil production began to surge in 2009 as oil extraction from tight oil formations became cost effective. Monthly U.S. crude oil production rose from about 4 MMBD in the third quarter of 2008 to nearly 13 MMBD in January 2020, about 3 MMBD more than its previous peak in November 1970 (EIA, 2021). The 40-year old ban on U.S. exports of crude oil, except to Canada, was lifted in 2015 (Langer et al., 2016) and U.S. crude oil exports expanded from near zero in 2015 to almost 4 MMBD in 2019. U.S. petroleum imports and exports were both near 9 MMBD in January 2020, reversing decades of large negative petroleum trade balance with the rest of the world. Since higher domestic production reduces net petroleum imports and wealth transfers to the rest of the world, increases in domestic oil production would have some positive effects on the U.S. economy. A number of prospective studies concluded that lifting the U.S. oil export ban would have a wide range of positive effects on the oil industry, consumers, employment and the trade deficit (Bordoff and Houser, 2015; Vidas et al., 2014). In addition, higher domestic oil production enables the U.S., as the largest oil consumer in the world, to play a larger role in the global oil market which is influenced by extra-market interventions by OPEC and other major oil producers, among other factors.

Despite the increase in domestic production, U.S. oil prices remain tightly linked to the global market, and the risks of large up and down movements in oil prices, known as “oil price shocks”, remain significant. For example, the spot price of Brent crude, a non-U.S. globally traded oil grade, rose from about $40/bbl to nearly $120/bbl between 2009 and 2014, as the world emerged from the 2008/2009 global recession, but dropped precipitously to a low of about $30/bbl in 2015. However, this drop was short-lived as the oil price again rose to about $70/bbl between 2016 and 2019, even as U.S. oil production surged and net imports dwindled. The spot price of Brent briefly dropped below $20/bbl in April 2020 as the Covid-19 virus outbreak became a global pandemic but was again near $70/bbl by June 2021. A key factor in oil price developments since 2014 is the response of other global oil producers to increasing U.S. production. Following the 2014/2015 collapse in oil prices, which coincided with lifting of the U.S. oil export ban, OPEC began to coordinate its oil production with Russia (together becoming known as OPEC+) to support oil prices (Behar and Ritz, 2017). Rapidly falling global oil demand in early 2020 counteracted OPEC+’s ability to support oil prices, and many members were reluctant to enact additional production cuts. Saudi Arabia, which had borne the burden of the production cuts for three years, announced surprise oil price cuts in March 2020 that sent global oil prices into a freefall, thereby ending that OPEC+ agreement.

On the one hand, production cuts to support high oil prices may increase OPEC+ revenues in the short-term but would increase the global market share of U.S. and other non-OPEC oil exports, reducing OPEC+ revenues, in the medium to long-term. On the other hand, lower oil prices may curtail U.S. oil production but would also reduce OPEC+ oil revenues. Baumeister and Kilian (2016) showed that U.S. oil investments declined significantly following the 2014/2015 oil price collapse. The extent of these counteracting effects is affected by the fact that the U.S. has one of the highest oil production costs in the world (Statista, 2015), whereas OPEC members have some of the lowest costs. Recent public discussions indicate that U.S. oil companies face pressure from investors to produce at levels that make domestic oil investments profitable (Kemp, 2021). Thus, the tug between higher cost U.S. oil production and the market share/price objectives of OPEC+ may increase, rather than decrease, global oil market volatility.

Oil price shocks are generally associated with economic dislocations and have received continued attention from policymakers and analysts since the oil market crisis of the 1970s. A key issue is how sensitive the U.S. economy remains to such price movements, given recent changes in the domestic oil supply-demand balance. The percentage change in gross domestic product (GDP) relative to the percentage change in the oil price, referred to as the “GDP Elasticity”, is a summary measure of the aggregate economic impacts of an oil price shock, and is a crucial input for the policy analysis of potential options to respond to oil price shocks. Given that the surge in U.S. oil production is recent, there are only a few studies focusing on the linkage between oil price shocks, higher levels of domestic oil production and the U.S. economy. This paper investigates changes in the U.S. GDP elasticity with respect to the oil price, controlling for important oil market variables, including domestic oil production and petroleum imports. The rest of the study is organized as follows. Section 2 provides an overview of the relevant literature on the determinants of an economy's response to an oil price shock under higher levels of domestic production and changes in the oil trade balance. Section 3 describes the data and autoregressive distributed lag (ARDL) model employed in this paper. Section 4 discusses the model results, and the paper ends with conclusions.