Since mid-summer, spot and forward oil prices have plunged. Lower energy costs will boost near-term U.S. GDP growth by raising real income, wealth, and hence consumer spending. Yet the recent rapid expansion of the domestic energy sector has created a new vulnerability.
By mid-2014 capital spending in the energy sector exceeded $150 billion, or 1% of GDP, the highest in three decades (Chart 1). While this expansion helped propel the current economic recovery, a drop in investment spending in the energy sector could now be a sizable offset to the boost in consumer spending from lower energy costs.
In theory, these capital expenditures should be positively correlated with the price of oil relative to the price of the capital goods in the industry. Chart 2 shows the history and, based on the early-January forward prices for WTI crude, a projection of this relative price. If today’s forward prices are realized, the industry is facing a long period of sharply reduced, weak investment incentives.
We estimated a simple model in which capital expenditures in the energy sector react to the real price of oil with a lag while cumulating to a long-run unit-elastic response. We used the model to estimate the impact on investment of the downward shift in the spot and forward prices of oil between late July and early January. The two cases are depicted quarterly in Chart 1, while annual average results are summarized in the nearby table. Under late-July price assumptions, investment falls to $124 billion by the end of 2017. Under early-January price assumptions, investment falls to $96 billion by the end of 2017, but the decline is concentrated in 2015.