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Pandemic, Oil Prices, and Aggregate Demand

Pandemic, Oil Prices, and Aggregate Demand

Stacy Knecht
Salt Lake Community College

4/29/20
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Pandemic, Oil Prices, and Aggregate Demand

March 2020 will be a month that most in the United States will not soon forget. The global

pandemic, COVID-19, started creeping across the country wreaking havoc on peoples’ health and bank

accounts. In order to contain and slow the spread of this devastating virus, federal and state

governments put social distancing orders in place. In places like New York, where the virus has hit

hardest, restrictions on shopping, traveling, socializing, and even working in non-essential businesses,

have been put into effect to save lives. Unfortunately, these orders and restrictions have brought the

closing of many non-essential businesses which include cruise ships, travel destination resorts, hotels,

restaurants, and many more. With the orders of staying home in effect, those who can work from home

are, leaving streets and freeways free from many drivers, and gasoline pumps free from buyers. With

current travel restrictions, people are not traveling or buying airline tickets. Long distance trucks are not

making as many trips because goods are not being produced and sold like before. The need for fuel and

crude oil has dramatically dropped, leaving fuel suppliers with a surplus and forcing them to drop prices

in order to move product. Oil is the world’s largest traded commodity, and as of 2017 the U.S. is the

world’s largest producer, with 18% of global production (Investopedia, 2020). The pandemic, an

external shock, has caused overall aggregate demand to decrease, and oil being the most traded

commodity in the world has certainly felt this same shift. In economics an external shock is described as

“any unexpected event that has a large-scale, unexpected impact on the economy” (Reed, 2020). The

American Economic Review in 2009 published similar findings after the 2008 housing market crash: “the

price of oil (like the price of any other commodity) is driven by distinct demand and supply shocks. Not

only does each of these shocks have different dynamic effects on the real price of oil and hence on the

US economy, but global demand shocks, in particular, may have direct effects on the US economy as

well as an indirect effect working through the price of oil” (Kilian, 2009). The lower demand for oil

means the oil industry will have to lay off thousands of workers, making GDP and investments drop

substantially. Because the oil industry plays such a large role in many other goods being produced and
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Pandemic, Oil Prices, and Aggregate Demand

transported, the external shocks felt by the oil industry can have affects on aggregate demand as well as

market demand.

Aggregate demand is “the total quantity of output demanded at alternative price levels in a

given time period” (Schiller & Gebhardt, 2020). Put simply, aggregate demand is the total amount of

goods and services demanded in an economy. Aggregate demand considers demand on a macro, or

wide lens view of the economy, whereas microeconomics may look at individual demand markets for

specific goods and services, like cars or healthcare costs. At first glance, observing the crude oil market

may seem like a microeconomic topic, but after taking a closer look, it’s hard to miss how the price of

crude oil affects the price of most other goods and services, making it a macroeconomic issue. When

looking at the macro economy, economist consider how three determinants will affect the outcomes of

the overall economy (Schiller & Gebhardt, 2020). The textbook, Essentials of Economics, lists the three

determinants as internal market forces, external shocks, and policy levers (Schiller & Gebhardt, 2020).

In our current circumstance of the COVID-19 pandemic, those three determinants could be interchanged

with, worried consumers, worldwide pandemic, and government stimulus programs. All these factors

have effect on economic outcomes or how well the overall economy performs; output, jobs, prices,

growth, and international balances (Schiller & Gebhardt, 2020). The Congressional Budget Office (CBO),

recently reported preliminary projections of expected performance in almost all the previously

mentioned economic outcomes. It is expected that the unemployment rate will average 14 percent in

the second quarter of 2020 (Swagel, 2020). That is almost 10 percent more than the first quarter’s rate.

This rise in unemployment is evidence of the labor force working well beneath its desired full

employment, or in other words, its full capacity of producing output (Schiller & Gebhardt, 2020).

Because unemployment has sharply increased, real gross domestic product (GDP) has declined

significantly in the second quarter, 39.6 percent from the previous quarter (Swagel, 2020).
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Pandemic, Oil Prices, and Aggregate Demand

To the consumer, lower prices at the pump may sound like a blessing, but to crude oil

producers, sharp drops in crude oil barrel prices can threaten their whole operation. The New York

times reported, “The price of the main U.S. oil benchmark fell more than $50 a barrel to end the day

[Monday, April 20, 2020] about $30 below, the first time oil prices have ever turned negative” (Reed &

Krauss, 2020). What does this mean for oil producers? The problem comes when market demand for

crude oil drops, producers are left with falling prices and the same amount of oil as before. This change

is illustrated by demand moving towards the left on the market supply and demand curves, creating a

market surplus or “the amount by which the quantity supplied exceeds the quantity demanded at a

given price” (Schiller & Gebhardt, 2020). Producers have to take a hard look at their ability to sell their

surplus crude oil supplies at a loss, or significantly lower their production which translates into laying off

employees and selling assets to cover losses on extremely low prices per barrel. Because of the large

surplus with no one looking to buy oil, producers are also looking for storage solutions and possibly

recouping lost sales on saved oil in the future. Cushing, Okla., one of the hubs of oil trade in the U.S., is

known for the amount of oil they can store, but already their 80 million barrel capacity is 74 percent

filled and expected to be at capacity by the end of May (Reed & Krauss, 2020). Lower prices per barrel

and few storage options are leaving “Many companies … already reporting substantial losses, and

experts [say] businesses across the oil patch will have to seek bankruptcy protection in the coming

months” (Reed & Krauss, 2020).

Global and state governments are not immune from this problem either. Countries who rely on

oil exports for a large portion of their economic wellbeing are feeling the cuts in demand acutely. The

New York Times reported last week, “The Organization of Petroleum Exporting Countries [OPEC], Russia

and other producers said they would cut 9.7 million barrels a day of production, or about 10 percent of

global oil output, the largest cut ever. It was a grim acknowledgment that global demand had collapsed”

(Reed & Krauss, 2020). Although, Texas, a state known for high oil production, has in recent years
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Pandemic, Oil Prices, and Aggregate Demand

started diversifying its state’s investments, Texas still has a large interest in U.S. oil production overall.

Last week, Scott Sheffield, the CEO of a large exploration and oil production corporation told members

of a Texas state commission called the Texas Railroad Commission, who regulate oil and gas drilling in

Texas, that he expects if price per barrel stays around $20 then “80 percent of the hundreds of

independent oil companies in the state would be forced into bankruptcy and 250,000 workers would

lose their jobs” (Reed & Krauss, 2020). Wyoming and Alaska, who both rely heavily on proceeds from

taxes and royalties provided by oil and gas production, are looking at a similar fate. For Alaska, the need

for oil production revenue is even greater because their expected revenues from tourism each year is

likely to take a sharp dive considering the pandemic and worried tourists (Mackrael, Blunt, & Frosch,

2020). CNN’s Chis Isidore reported at the beginning of March, domestic oil production and refineries

employ roughly 540,000 people, while gas stations employ about 945,000 (Isidore, 2020). While gas

station employees may experience a small amount of unemployment because of social distancing,

pandemic conditions, and a decrease in revenue from fewer people driving, some are saying that cuts in

demand and oil production may lead to a loss of 70 percent of oil production and refining employees

(Reed & Krauss, 2020).

Drops in market demand for oil production will have consequences on aggregate demand for

our overall economy. What the full outcome will be is hard to say right now, but when a dominating

market, like the oil and gas market, take a loss as hard as the one it is experiencing right now, the ripples

will likely touch everything. The components of aggregate demand- government spending, investment

spending, consumption spending, and exports, will all be affected (Schiller & Gebhardt, 2020). With oil

businesses facing bankruptcy, investors and banks will not be making loans and buying stocks. Exports

will also drop off because of lack of production. With oil production employees facing layoffs, the loss of

income will make purchasing goods and services more difficult. With more people applying for

unemployment benefits, the government may start spending more than it is bring in, creating a deficit.
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Pandemic, Oil Prices, and Aggregate Demand

Jim Burkhard, an oil market expert, said recently about dismal market declines: “Oil and gas investment

has grown to be a large and important source of U.S. business investment and employment over the

past 10 to 15 years, so the decline in prices and falling investment will have a negative impact on the

U.S. economy” (White, 2020). This has already been the case and may continue to be for the next while

until economic recovery happens.

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Pandemic, Oil Prices, and Aggregate Demand

References
Investopedia. (2020, April 22). The World's Top Oil Producers of 2019. Retrieved April 28, 2020, from

https://www.investopedia.com/investing/worlds-top-oil-producers/

Isidore, C. (2020, March 10). Low oil prices could damage the US economy. Retrieved April 28, 2020, from

https://www.cnn.com/2020/03/09/business/oil-prices-us-economic-impact/index.html

Kilian, L. (2009). Not All Oil Price Shocks Are Alike: Disentangling Demand and Supply Shocks in the

Crude Oil Market. American Economic Review, 99(3), 1053–1069. doi: 10.1257/aer.99.3.1053

Mackrael, K., Blunt, K., & Frosch, D. (2020, April 21). Oil Price Rout to Hit U.S. Regional Economies.

Retrieved April 22, 2020, from https://www.wsj.com/articles/oil-price-rout-to-hit-u-s-regional-

economies-11587508075

Reed, E. (2020, February 6). Economic Shocks: Definition and Examples. Retrieved April 29, 2020, from

https://smartasset.com/financial-advisor/economic-shock

Reed, S., & Krauss, C. (2020, April 20). Too Much Oil: How a Barrel Came to Be Worth Less Than

Nothing. Retrieved April 22, 2020, from https://www.nytimes.com/2020/04/20/business/oil-

prices.html?action=click&module=RelatedLinks&pgtype=Article

Schiller, B. R., & Gebhardt, K. (2020). Essentials of economics. New York: McGraw-Hill Education.

Swagel, P. (2020, April 24). CBO's Current Projections of Output, Employment, and Interest Rates and a

Preliminary Look at Federal Deficits for 2020 and 2021. Retrieved April 28, 2020, from

https://www.cbo.gov/publication/56335

White, M. C. (2020, April 22). Will oil's price slump be worse for the economy than the effects of the

coronavirus? Retrieved April 22, 2020, from https://www.nbcnews.com/business/energy/will-oil-

s-price-slump-be-worse-economy-effects-coronavirus-n1189001