Energy is vital for modern economies. It is hard to imagine how agriculture, industry, and transportation would work if oil or gas ran out tomorrow. This level of dependence on non-renewable energy sources naturally raises the question: How does oil impact the economy? What would happen to my country if the price of oil doubled tomorrow?
Over the last decades, dozens of studies have been conducted, and various models of oil price–economic growth dependence have been built. In this article, we will try to bring them all together and show by examples how the price of petroleum affects the economy.
Oil Prices and Economic Growth
When people talk about the impact of oil prices on the economy, many people imagine a simple scheme: if oil goes up in price, the economy grows; if it goes down in price, the economy slows down. However, the reality is much more complex.
Research shows that there is not a strict direct correlation between oil prices and economic growth. Instead, oil affects the economy through a variety of factors—interest rates, government spending, investment, exchange rates, and more. These determinants can both stimulate and slow economic growth.
Oil is a key resource in many countries, but its impact on GDP is far from straightforward. For example, a study by Frimpong et al. shows that the impact of oil prices depends on the economic mechanisms through which they are transmitted. In West African countries, according to their analysis, higher oil prices only contributed to economic growth through interest rates. In contrast, factors such as exchange rates, government spending and investment inhibited economic development. This confirms that it is important to consider through which channels the oil price affects the economy rather than just looking at the price itself.
The US example also shows the complexity of the relationship. In the 1990s and early 2000s, the economy suffered from dependence on imported oil. Domestic production did not cover needs, and rising oil prices hit the economy. However, with the development of extraction technologies (primarily shale fracking), the situation changed. High oil prices motivated the development of domestic oil production, which turned the U.S. into one of the world’s largest producers. Now, the US is also facing problems with falling oil prices. Oil companies are losing profits, investment in production is declining, and regions dependent on the oil industry are experiencing economic decline.
So, as you can see, oil prices can either accelerate or decelerate economic growth, depending on what factors are at play at any given time. For example:
- In oil-exporting countries (Russia, Saudi Arabia, Kuwait), rising prices increase budget revenues, government spending, and investment, which supports economic growth.
- In oil-importing countries (Europe, Japan, India), higher oil prices increase the cost of production and transportation, leading to higher inflation and a slower economy.
- In countries with developed oil production (USA, Canada), the effect can be mixed: a high oil price supports the oil sector but hits other industries.
In other words, oil affects the economy not directly but through a system of different channels. In the next part of the article, we will analyze the main determinants of oil’s effect on economic growth.
Oil and Inflation
Economists have long studied the impact of oil prices on inflation and economic growth. Research by Kilian and Lewis shows that higher oil prices lead to an increase in the general price level, which in turn affects economic activity. Nordhaus specifies that this effect is particularly pronounced for headline inflation, which includes energy and food prices, rather than core inflation. At the same time, Bernanke and his colleagues emphasize that rising oil prices have an impact not only through inflation but also through higher interest rates, as central banks use this tool to combat inflation risks. In some cases, as Kilian notes, higher oil prices can even cause deflation by reducing consumer demand.
The relationship between oil prices and inflation is evident in historical data. The graph below illustrates key moments when rising oil prices triggered inflationary spikes:
A line chart showing oil price movements, highlighting spikes during major inflationary periods
In the 1970s, the world economy’s dependence on oil was much higher: it took more than a barrel of oil to produce every thousand dollars of U.S. GDP. That’s why oil shocks of that period led to a spike in inflation. Today, the situation has changed. By 2019, the same figure has fallen to 0.4 barrels, which has weakened the impact of oil on the overall price level.
However, this does not mean that oil no longer plays a role in inflationary processes. According to research by the Dallas Fed, every $10 per barrel increase in oil prices increases inflation by 0.2% and slows economic growth by 0.1%.
It is important to realize that oil affects inflation in two ways:
- The direct impact is the rising cost of fuel and energy, which make up as much as 7.3% of the consumer basket. This is especially noticeable in the United States, where half of the cost of gasoline is determined by the price of oil.
- The indirect impact is the rise in prices for raw materials and transportation, which increases the cost of goods and services (for example, plastic becomes more expensive, increasing the price of packaging and electronics).
Oil’s impact on inflation has increased again in recent years. This is due to the growing popularity of renewable energy sources, which remain more expensive than traditional hydrocarbons. Also, global supply chains are increasingly being replaced by local ones, which increases production costs. Thus, despite the decreasing dependence on oil, this resource remains one of the key drivers of inflation.
Oil and Transportation
The transportation industry is one of the first to feel the effects of oil price fluctuations. It makes sense: most transportation vehicles – from trucks and trains to offshore tankers and airplanes – run on petroleum products. Fuel costs can account for up to 40% of a carrier’s operating budget, which means that any significant change in the price of oil has an immediate impact on transportation costs.
When oil prices rise, transportation companies are forced to incorporate these costs into the cost of their services. This is most often done through fuel surcharges, which allow airlines, shipping companies, and trucking companies to automatically raise fares based on the current cost of fuel. The result is higher airfares, freight costs, and prices for goods for the end consumer.
The reverse is also possible: when oil prices fall, transportation costs decrease, which stimulates consumption. The example of 2008-2009, when oil prices more than halved amid the global financial crisis, shows that this can lead to cheaper air travel, lower logistics costs, and even partial recovery of consumer demand.
The graph below highlights fluctuations in global fuel prices over the past decades, showing how oil price volatility directly impacts transportation costs and consumer goods pricing:
A comparative bar chart showing fluctuations in global fuel prices over time, demonstrating the correlation between oil price volatility and transportation cost surges.
However, we should not forget that the price of oil is not the only factor affecting transportation costs. For example, in 2022, the average price of diesel fuel in the U.S. rose from $3 to $5 per gallon (more than 60% in a year and a half), hitting the trucking industry hard. But in addition to rising oil prices, the same period saw severe driver shortages caused by the pandemic, fluctuating demand and parts supply issues, which further increased logistics costs.
Thus, the price of oil is indeed a key determinant of transportation costs, but not the only one. In the long term, as electric vehicles and alternative fuels develop, the impact of oil prices on the industry may diminish.
Oil and Geopolitics
The oil market has never existed in a vacuum. Any significant political or military tension in key oil-producing regions inevitably affects oil prices and, consequently, the global economy. Goldman Sachs Research emphasizes that the impact of geopolitics on the oil market will remain extremely high over the coming year.
How conflicts and sanctions affect the price of oil
One of the most striking examples of geopolitical influence is the situation with Iran. If Iran’s oil supply is reduced by 1 million barrels per day, which could happen if sanctions are strengthened, Brent prices could rise to $85 per barrel by mid-2025. A tougher U.S. policy toward Iran could lead to a further reduction in exports, but analysts believe this effect will be weaker than in 2018-2019. Back then, Iranian liquid hydrocarbon exports fell by 2.4 million barrels per day, almost nullifying supplies to OECD countries.
China plays a serious role in this issue, as it is now the largest buyer of Iranian oil. Now, 90% of Iran’s oil exports go to China, which reduces the overall effect of sanctions from the US and Europe. However, possible changes in Chinese economic policy or increased tensions between Washington and Beijing could drastically change the situation.
Another factor that can disperse oil prices is the escalation of conflict in the Middle East. If US support for Israel increases, Goldman Sachs predicts that the likelihood of disruptions in oil supplies from Iran will increase. In such a scenario, a six-month reduction in Iranian exports by 1 million barrels per day could temporarily push Brent prices to almost $90 per barrel.
However, geopolitics can also work in the opposite direction. For example, if the US widely applies import tariffs, especially under the Trump administration, the global economy could slow down, reducing demand for oil. Goldman Sachs estimates that if the U.S. imposes 10% tariffs on imports, the price of Brent could fall below $60 per barrel by 2026.
What does this mean for the economy?
Oil prices are an indicator of global economic health. High prices boost the incomes of exporting countries but slow down importing economies by increasing inflation and transportation costs. Low prices, on the other hand, benefit oil import-dependent countries but create risks for producers and can lead to instability in commodity economies.
Oil and Industry
Industrial development is one of the key factors of economic growth. Without a stable industrial base, countries face slowing growth, declining incomes, and rising unemployment. However, the successful functioning of the industrial sector is impossible without reliable and affordable energy resources, among which oil plays a central role:
- Fuel for transportation
- Plastics and chemical production
- Building materials production
- Energy supply for companies
- Transportation of raw materials and finished products
Countries with developed industries, especially OECD countries, traditionally consume a high amount of oil. According to statistics, from 1971 to 2015, oil consumption in OECD countries was 2.5 times higher than the world average. This indicates that the industrial strength of these countries is strongly linked to the availability of oil and its price level.
Logically, rising oil prices increase enterprises’ costs: transportation becomes more expensive, energy prices rise, and production processes require more inputs. This can lead to lower profitability, less investment in production expansion, and even the closure of companies that cannot compete.
It is therefore logical to assume that if expensive oil hurts the industry, its cheapening should contribute to production growth. However, it is not that simple. Industry does not react to falling prices as quickly as to their growth.
For example, a sharp decline in oil prices can:
- Make investment in the energy sector unprofitable
- Reduce the attractiveness of new technologies and projects in petrochemicals
- Cause oil producers, especially shale oil companies, to go bankrupt
This is especially true in the US, where the shale industry provides a significant number of jobs. When oil becomes too cheap, production stops, investors lose money, and regions dependent on the oil industry experience economic recession.
The ideal scenario for the industry is stable and predictable oil prices. Oil that is too expensive makes production unprofitable, and oil that is too cheap destabilizes commodity markets. Therefore, industrialized countries are interested in controlling oil prices and diversifying their energy sources. In recent years, the OECD has been gradually reducing dependence on oil through the development of renewable energy sources, but oil remains the most important factor in industrial growth.
Oil and Employment
Oil prices determine the cost of fuel and energy and have a direct impact on the labor market. Let’s begin with the examples.
Shale oil regions are particularly dependent on oil prices. The shale oil boom in the U.S. in the 2010s was a catalyst for job growth, but as soon as oil prices fell, employment in the sector declined.
Shall we examine how expensive oil creates jobs? Sure thing.
Shale oil production requires constant drilling, as fracked wells are quickly depleted. This means that constant investment in new projects is needed to maintain production levels, leading to increased employment in areas such as:
- Exploration and drilling: engineers, geologists, drillers
- Oil transportation: forklift operators, truck drivers
- Infrastructure maintenance: mechanics, pipeline construction workers
- Related industries: hotels, restaurants, car dealerships in oil regions
When oil prices are high, companies expand production, create new jobs, and stimulate business development around production sites. This boosts local economies and increases consumption, which supports economic growth.
However, this effect also works in the opposite direction.
When oil prices fall, investment in drilling declines, leading to massive layoffs in the oil and gas sector. This is particularly noticeable in shale regions of the US, where production costs are higher than conventional fields. If a barrel of oil costs less than a certain threshold, new projects become unprofitable, and companies are forced to freeze production.
The results of this downturn extend far beyond the oil sector. Workers who lose their jobs on the rigs cut back, leading to lower revenues for local businesses, from restaurants to car dealerships. This creates a chain reaction in the economy, where a single job cut in the oil industry can lead to dozens of layoffs in other sectors.
Another group that suffers from falling oil prices is financial institutions. Many oil companies finance their operations through loans and bond issues. When oil prices fall, profitability declines and the debt load becomes unsustainable. This can lead to company bankruptcies, which hit investors and banks, who lose their investments.
Although the financial sector is well aware of the risks, massive defaults by oil and gas companies can undermine capital market stability. Collectively, this slows economic growth, reduces investment, and increases economic instability.
Conclusion? Oil prices are a key factor in employment.
The Future of Oil’s Impact on the Economy
Let’s summarize all of the above.
Despite global trends towards renewable energy, oil will remain a key driver of economic growth in the coming decades. Industrial, transportation, and energy development remain dependent on oil, and the high volatility of commodity prices will continue to create both opportunities and risks for the global economy. Oil-exporting countries will remain exposed to fluctuations in revenues while importing nations will balance the need for stable supplies with the desire to reduce dependence on hydrocarbons.
In the long term, oil prices will be determined by geopolitics, technological advances, and the policies of leading countries. Possible increased regulation of the hydrocarbon sector, new discoveries in alternative energy, and changes in demand from emerging economies could dramatically change market dynamics. However, as long as oil remains the backbone of the global economy, its value will remain a key indicator of economic prosperity and stability.
