Decline in Oil Prices Offers Valuable Lesson

By Jonathan Small

At some point in our lives, we’ve all been positively impacted by that bubbly substance deep within the ground that immortalized “The Beverly Hillbillies,”… oil. Much of our everyday life comes in contact with petroleum or its by-products, whether it is the mode of transportation we use, a container that holds our food, or numerous other products.

Given oil’s impact on our daily lives, it’s no wonder how price sensitive the world’s economy has become to the source of what makes most transportation possible.
Recent declines in the price of oil provide a valuable lesson. One of the basic concepts of economics is that as more of a good is produced, with steady demand, eventually the price to acquire that good will decrease. For years, it seemed as if geo-political and government monetary policy would make the laws of economics inapplicable to oil prices.

However recently, innovations in oil and gas extraction methods have become widely used. One process for extracting oil and gas from shale formations in the ground is known as “fracking,” which stands for hydraulic fracturing. This process isn’t new, it was actually invented in the 1940’s. As Investopedia.com notes, “Fracking refers to the procedure of creating fractures in rocks and rock formations by injecting fluid into cracks to force them further open. The larger fissures allow more oil and gas to flow out of the formation and into the wellbore, from where it can be extracted. Fracking has resulted in many oil and gas wells attaining a state of economic viability, due to the level of extraction that can be reached.”

Across the United States, oil and gas formations that used to be untapped or hard to access have now become a thriving environment for extraction. The production of oil and gas has been an incredible boon for the US economy because extraction also creates a vast array of jobs. Federal and state tax revenues have also benefited. In fact, authors Steve Moore, Rex Sinquefield, and Travis Brown have noted that much of the private sector job growth in the U.S. since the Great Recession is a direct result of oil and gas exploration.

Although it’s taken time, the enormous growth in the supply of oil and gas reserves and other available resources has led to a sharp decline in prices. This is great news for U.S. consumers. Some economists estimate that the drop is the equivalent of real income growth of more than $1,000 per household.

The decline in oil prices, in response to human productivity and exploration, is a lesson in economics that also carries with it a warning. Recent efforts by the Environmental Protection Agency to further attack coal fired energy production by restricting supply through its Clean Power Plan will have real consequences. As Oklahoma Attorney General Scott Pruitt and I recently noted in an op-ed for The Hill, “Those hurt most by the Clean Power Plan will be the most vulnerable among us-the poor, the single mothers, the elderly and minorities. Households earning less than $10,000 per year spend an astounding 60-80 percent of income on energy costs, and those earning between $10,000 and $30,000 per year spend greater than 20 percent of their income on energy. It is no surprise that the inability to pay utility bills is the leading cause of homelessness in U.S. The EPA’s proposed rule could increase the typical household’s annual electricity and natural gas bills by $680, or 35 percent, by 2020, escalating each year thereafter as EPA regulations grow more stringent, according to a study by Energy Venture Analysis.”

The concept of supply and demand matters. Let’s hope policymakers learn from the positive effects of an increase in the supply in oil, and apply that understanding to stopping the EPA from imposing the opposite effect on millions of families.

Guest post by Jonathan Small, president of the Oklahoma Council of Public Affairs.

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