A Possible Economic Slowdown and
Its Impact on Oil Demand

Economic analysts became concerned about the durability of the U.S. economic expansion earlier in 2007 due primarily to the apparent weakness in the housing market and the possibility that this weakness would spread to other sectors of the economy. By August 2007, U.S. economic policy makers, households, and firms became even more concerned about the economy as financial market conditions deteriorated. Last Friday’s Employment Report released by the U.S. Bureau of Labor Statistics reported a small decline in U.S. non-farm payroll employment, the second disappointing monthly report on employment in a row. This report resulted in economic analysts marking up their assessments of the chances of a recession in the United States during 2008. Their fear is that with unsettled financial markets and increased uncertainty regarding job prospects, households and businesses will cut spending, resulting in a decline in economic activity – a recession.

Against this backdrop, it is natural to consider the impacts of a recession, should it occur, on petroleum markets and petroleum demand. When we posed this question to one of our resident economists, we received an answer typical from practitioners of that discipline: “It depends on whether households, firms (including oil producers), and economic policy makers anticipate an economic contraction and what actions households, firms and policy makers take in response to this concern.” Not clearly understanding the implications of this open-ended response, we asked him to expand on it.

A recession in the United States economy will have a significant effect on the demand for petroleum products. However, as oil prices have moved from $3 per barrel in the early 1970s to $90 per barrel today, U.S. firms have found more energy efficient ways to produce goods and services. In addition, as oil prices have risen, firms have chosen to move production abroad to areas where the costs of other factors of production (primarily wages) are lower to offset the increase in the price of energy so that they could remain competitive in their delivery of goods and services. Statistics aside, since the use of energy is an integral part of the production of nearly all goods and services in an advanced economy such as the United States, a decline in U.S. economic activity would result in a decline in energy use. But, by how much? CLICK HERE FOR FULL STORY