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Irina Slav

Irina Slav

Irina is a writer for Oilprice.com with over a decade of experience writing on the oil and gas industry.

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The Oil Crisis Puts The Entire U.S. Economy At Risk

Job losses, well shut-ins, and bankruptcies have replaced the praise surrounding the shale oil boom that greatly enhanced America's energy independence and gave President Trump a reason to tout energy dominance. Now, the federal government is mulling over ways to help the industry curb its losses amid historically low prices and little chances of their improvement anytime soon.  And the crisis will have much wider repercussions.

The trough of the oil industry cycle always harms the broader economy, usually on a regional level. During the last crisis, for example, once-thriving towns in Texas and New Mexico shrunk as mass layoffs dealt a blow to the local economies. This is bound to repeat again and already is: the Wall Street Journal reports state economies from Wyoming to Alaska, Oklahoma, and North Dakota are taking a hit from the oil industry's crisis.

According to the American Petroleum Institute, the oil and gas industry in the United States supports as many as 10.3 million jobs and generates close to 8 percent of gross domestic product. This is, of course, nowhere near the over 50 percent that oil makes up in the Saudi GDP, but it is a portion sizeable enough to suggest that a crisis in the oil industry could have a ripple effect on the national economy. The question is, how strong this ripple effect would be.

According to a Goldman Sachs analyst, it has the potential to be quite strong. "Typically, oil price fluctuations have a small aggregate impact on U.S. growth, with roughly offsetting effects from the energy capex and consumption channels," Paul Choi wrote in a note cited by Axios. "However, the sharp rise in the likelihood of bankruptcies in the energy sector and spending constraints due to the virus suggest that the decline in oil prices might be a larger drag on growth this time."

Related: 7 Oil Countries Hit Hard By The COVID-19 Crisis

In all fairness, the extent of the damage that the oil crisis could do to the U.S. economy might not be that serious, at least against the backdrop of the wider slump caused by the coronavirus pandemic. Analysts indeed expect more bankruptcies, more spending cuts, and less investment, all of which means less money flowing into state and federal budgets and people's bank accounts as layoffs expand.

And yet the cumulative drag from the oil crisis on U.S. economic growth is seen at 0.25 percent. That's compared with a forecast of double-digit economic slumps this quarter and for the full year, even from the optimistic analysts who expect a V-shaped rather than U-shaped recovery.

The doomsday scenario has recently stepped away from the spotlight as the easing of lockdown measures across the States has given rise to optimism about the immediate future of oil demand. Goldman Sachs said earlier this week, as quoted by Business Insider, that oil demand is about to start recovering fast--but it won't recover fully, with jet fuel demand suffering a longer-term decline, according to the bank. Supply, meanwhile, might never reach pre-crisis levels, Goldman warned.

Indeed, there have been warnings that well shut-ins in response to the low oil price environment may lead to a permanent loss of production. This could affect future output as much as continued spending control after the pain of the crisis. Even so, the repercussions from this pain seem like they would have a limited effect on the national economy as a whole. But only relatively: relative to the damage the pandemic is expected to have on U.S. growth, which pretty much everyone, including the federal government, expects to be the worst blow to GDP since the Great Depression.

By Irina Slav for Oilprice.com

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  • Mamdouh Salameh on May 13 2020 said:
    While the US oil and gas industry contributes 8% to the United States’ GDP compared with 30% for Russia and 50% for Saudi Arabia, oil through the petrodollar virtually underpins the United States’ financial system and economy.

    And contrary to claims otherwise, the role oil plays in the US economy is far more dominant than in the economies of Russia and Saudi Arabia for instance.

    Today, oil through the petrodollar is the core of the US financial system. Undermine the petrodollar and you undermine the whole US financial system and the US economy.

    Because nearly everybody uses the US dollar to buy oil and to trade with one another, this creates a tremendous demand for US dollars around the planet. So other nations are generally happy to take US dollars in exchange for oil. Major exporting nations accumulate huge piles of dollars a big chunk of which is invested in US Treasury bonds.

    US Treasury bonds fuel the print-borrow-spend cycle that the US economy depends upon. That is why a US debt default would be such a big deal. A default would cause interest rates to skyrocket and the entire global economic system to go haywire.

    The petrodollar system provides at least three immediate benefits to the United States. It increases global demand for US dollars. It also increases global demand for US debt securities and it gives the United States the ability to buy oil with a currency it can print at will. In geopolitical terms, the petrodollar lends vast economic and political power to the United States. Maintaining the petrodollar is America’s primary goal. Everything else is secondary.

    China has been planning for years to dethrone the US dollar. That is why the launching of the petro-yuan in March 2018 was a “wake up call” for the United States. Moving oil trade out of the petrodollar into the petro-yuan could seriously undermine the US financial system and therefore the US economy.

    With major oil exporters finally having a viable way to circumvent the petrodollar system, the US economy could soon encounter severely troubled waters. First of all, the dollar’s value depends massively on its use as an oil trade medium. When that is diminished, we will likely see a strong and steady decline in the dollar’s value.

    Hitherto, the US dollar has had the monopoly over oil contracts as it enjoyed the status of the only currency in which major oil contracts could be made. This meant that US could get away by having outstanding debts estimated at more than $23 trillion and rising.

    Dr Mamdouh G Salameh
    International Oil Economist
    Visiting Professor of Energy Economics at ESCP Europe Business School, London

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