Oil Economics

America’s oil addiction reaches into every aspect of our economic lives. On a national level, it determines large-scale inflows and outflows of money and capital, triggers recessions and fuels inflation. And on an individual level, our dependence on oil has a profound impact on how much Americans earn, spend and save, and whether they will be prosperous or poor.

The Big Picture

  • On a macro level, the biggest impact is from imported oil, which drains resources otherwise invested in the domestic economy. Of the $700 billion America spent on oil last year, more than half of that — about $380 billion — went to pay for imported petroleum. We also exported refined products from domestically produced oil, worth about $50 billion, so the net cost to the economy of imported oil was about $330 billion.
  • How much is that? One year’s spending on foreign oil accounts for about half of our annual trade deficit, is equal to nearly half of President Obama’s first stimulus plan, or half of the total amount spent directly on the Iraq War. No other commodity comes close to matching what we spend on oil. For example, coal costs $30 billion annually — 4% of what goes to oil.
  • Economist James Hamilton of the University of California, San Diego, who has researched the correlation between U.S. economic activity and oil prices, found that 10 of the last 11 recessions were preceded by spikes in oil prices.

Oil Prices

  • The economic impact of money spent on foreign oil is far less than if the fuel were produced here. Every dollar spent on gasoline at the pump generates 40 cents of economic activity because most of that dollar goes to pay foreign producers. Domestically produced fuels, on the other hand, benefit from the multiplier effect with each dollar spent generating an estimated three dollars in economic activity.
  • This means that, if all of the $330 billion spent last year on imported oil remained in the United States, it would generate nearly $1 trillion in new economic activity — jobs, spending, investment, etc. — and raise the GDP by 2.5% a year. That’s approaching the pace of growth — 2.9% (adjusted for inflation) — for all of 2010.
  • The U.S. Energy Information Administration calculates that a $20 increase in the price of a barrel of oil — about equal to the 2011 rise in oil prices — reduces annual GDP growth by 0.4% and increases unemployment by 0.1 percentage points in the first year alone. So the additional $125 billion paid for imported oil in 2011 wiped out the impact of President Obama’s middle-class tax cut and another increase in 2012 likely would have the same effect on an extension of the payroll tax cut.
  • But slow economic growth does not lead to lower oil prices. Despite economic slowdowns in the United States and Europe, oil prices remain around $100 a barrel.
  • Why don’t oil prices fall? Because demand in rapidly urbanizing nations like China and India is growing faster than oil supplies come online, at the same time that sources of cheaper oil are being exhausted. Oil that can be extracted and sold at $50 dollars a barrel is diminishing. As recently as 2003, the average price of oil was under $25 a barrel.
  • The indirect economic impact of foreign oil includes major U.S. Defense Department spending on troops, ships, weapons and equipment deployed around the globe to protect the free flow of oil. This reality is driven home by the U.S. Navy’s recent deployment of warships to the Strait of Hormuz in response to Iran’s threat to block the critical oil transport route.

Jobs, Consumers and the Poor

  • America’s oil addiction also has a major impact on jobs. The U.S. workforce is roughly 150 million people, and it costs roughly $100,000 per year per full-time U.S. worker. If $330 million exits the U.S. economy each year to pay for foreign oil, that’s equivalent to roughly three million jobs lost, or conversely, three million jobs that would be created if all of that money stayed at home.
  • As with many aspects of the economy, the poor and lower-income Americans are disproportionately damaged by our dependence on oil. Paying for gasoline at the pump serves as a regressive tax on lower-income families, and especially the 40% of Americans at or near the poverty line who spend a larger share of their incomes on fuel.
  • Middle — class Americans who have been forced to the exurbs to find affordable housing are also among the hardest hit because they are saddled with lengthy commutes to and from their jobs, often well over 100 miles a day.
  • American households spent a record $4,000 each on gasoline in 2011, 8.4% of their total income. Overall, the U.S. spent more on fuel–$700 billion — in 2011 than on food–$600 billion. The average U.S. household spends more each year on transportation than on clothing, healthcare and entertainment combined. Households also spend nearly as much on gasoline each month as they do on car payments.
  • U.S. consumers also pay indirect costs as businesses pass along higher transportation expenses caused by rising oil prices (to say nothing of the higher cost of petroleum-related materials in their products). One example: air fares. As oil prices were rising to $100 a barrel in 2010 and 2011, airline fares increased by 12.1%.
  • Imported oil creates two types of wealth transfers from the millions of Americans who each day buy gasoline at the pump: Money that goes overseas to petroleum suppliers and money that is paid to a handful of domestic producers. In this way money spent on gasoline contributes to a concentration of wealth. Exxon Mobil Corp., with a market capitalization of over $400 billion, is not only the largest oil company in the world, it rivals Apple Inc. as the world largest corporation. Much of its earnings are spent on operations, people and investments abroad, not in the United States.

These are some of the reasons why opening U.S. markets to replacement fuels — ethanol, methanol and natural gas — as well as drilling for more domestic oil and encouraging production of electric cars — is critical to our economic future. Not only will the U.S. economy benefit by investing $300 billion-plus that once was spent annually on imported oil, but new competition in the fuel market will drive down gasoline prices as well. And because replacement fuels generate fewer toxic emissions, the economy overall will benefit from directing resources away from emissions clean-up toward more productive uses.

In this new economic environment, businesses — even major oil companies — will be spurred to innovate, aggressively pursue development of ever-more efficient fuel sources and vehicles, and then reap the financial rewards. Apple didn’t reinvent itself through incremental change; it did this through creative, game-changing innovation that resulted in wildly popular, iconic products such as the iPod, iPhone and iPad.