Asymmetric Effects of Oil Price Shocks: Kentucky Comparison

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Recent gains in U.S. oil and natural gas production have spurred debates about the strengths and vulnerabilities of the domestic energy market. Technological advances along with high oil and gas prices spurred increased production and exploration of the abundant oil and natural gas resources here within the U.S. The recent oil boom, though positive and beneficial in many respects, does have its own vulnerabilities. Furthermore, these drawbacks do not affect all states and all sectors of the economy equally – the effects of the domestic price shocks to oil production and exploration are asymmetrically distributed. This suggests that some sectors are affected in different ways, to varying magnitudes. For example, in Kentucky this could be beneficial to many industries that have large economic impact – transportation, manufacturing, the automotive industry, etc. – and harmful to others such as mining. It even has serious tax implications that affect consumer spending and roads maintained by the Kentucky Road Fund and the gas tax formula.

According to GasBuddy.com, the average price of gasoline one year ago was $3.43. Currently the price is $2.31. Though the price over the past year has fluctuated, that is an annual decline in Kentucky gasoline prices – which roughly mirrors the same trend in the price of crude oil – of 32.7%. This is a significant drop. If you contrast the recent decline with the general upward trend that has been consistent since 2009, the magnitude of the recent decline appears even more pronounced.

Historical Kentucky Gas Prices

Historical Kentucky Gas Price (Data from U.S. Energy Information Administration)

 

 

Now looking at the recent trend downward, what can we expect to happen if it continues? According to a study prepared for the Kentucky Department for Energy Development and Independence, oil price fluctuations have greater effect on production and output as compared to other sources of energy such as natural gas and coal. In short, this study found that a price decrease in crude oil yields a net positive impact, taking time effects into account, even though there may be short-term losses to total Kentucky Employment and Gross State Product. Though coal is not perfectly substitutable for crude oil and natural gas in regards to energy production, as the price of other energy substitutes for coal decrease, this could affect areas like eastern Kentucky that are heavily reliant on the mining industry. Due to the decreasing price of crude oil and natural gas, the relative price of coal increases which affects its demand. In the short-run, coal is rather sensitive to price changes – a 1% increase in its price  results in a 0.64% drop in aggregate coal consumption. Though Kentucky still is heavily reliant on coal for energy production, the closure of coal-fired power plants in other areas in recent years lowers Kentucky coal exports and created surplus coal stockpiles. The additional factor of lower crude oil and natural gas prices only compounds this effect.

The negative impact on mining however does not span all industries. Consider the shipping industry in Kentucky. Kentucky is a global hub for the shipping and transportation industry. Shipping and transportation companies – such as DHL Express and UPS which both have air hubs at Cincinnati/Northern Kentucky International Airport and Louisville International Airport respectively – stand to gain most from reduced crude oil and energy prices. With gasoline and fuel being a major input for these industries, their operating costs are being curtailed. Falling oil prices could also have the same effect on input prices for another major Kentucky transportation industry – trucking. The decrease in fuel costs allows industries like trucking to operate at lower costs and structure operations around demand issues rather than saving on fuel costs.

Similar effects can also be seen in other industries where energy is a major input. Manufacturers of consumer goods and goods that involve oil derivatives, either to operate or produce, will see significant positive impacts as well. Automobile manufacturing being the most obvious example pertinent to Kentucky. Warren County, being the center of Chevrolet Corvette manufacturing in the US, stands to gain from a prolonged decrease in oil prices. Not only now are the automobiles cheaper to manufacture, but from the consumers’ perspective, they are also cheaper to purchase and operate. Manufacturing in Kentucky makes up nearly 14% of economic activity according the US Census Bureau. With manufacturing, automobile manufacturing being a portion of that, being such a substantial part of the Kentucky economy, gains from decreasing oil prices cannot be understated.

One more subtle effect of decreasing oil prices is the effect that a prolonged decline could have on road maintenance and constructions. The Kentucky Gas tax – which makes up more than 50% of the revenue for the Kentucky Road Fund – is calculated at nine percent per gallon of the wholesale price of gasoline. The recent decrease essentially acts as a tax cut for consumers but at the same time puts pressure on the Kentucky Department of Transportation to make up the difference for road maintenance. Though the effect on consumers is mainly one-sided in regards to basic tax implications, the safety and efficiency of roadway construction could experience some negative side effects. Dropping crude oil and gasoline prices coupled with more fuel efficient cars may push legislators to restructure the gas tax formula.

Though Kentucky is not affected the same way as many states that have larger deposits of crude oil and natural gas such as Texas and North and South Dakota, the effects of decreasing energy prices on those areas only further illustrate the asymmetric effects previously mentioned. If we look at the overall output of the oil and energy industries as a function of price and quantity, as the price of energy decreases, assuming quantity produced remains equal, revenue decreases in the same way that price is decreasing. So the drop in price of oil and energy is not a positive signal for those areas that rely on oil and energy as economic strengths. Many media outlets such as CBSNPR, and CNN all recognize the possibility of employment cuts and losses in economic growth in these sectors due to prolonged decreased prices, but looking at current employment figures these losses have yet to be realized at the national level.

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US Oil and Gas Extraction (Data from U.S. Bureau of Labor Statistics)

Overall, the recent decline in oil and energy prices is a mixed bag with multiple asymmetries. Kentucky is a prime example of those unequal effects. Though the cumulative impact of a decrease in crude oil and gas prices appear to be overall positive across time, the size and magnitude of those effects are unequally distributed across countries, states, and business sectors.