Gas at $2.50 per gallon will stimulate the economy

Gasoline pump.
Going down? Prices at the pump are headed in the right direction: down. (Via Wikipedia)

WASHINGTON, December 2, 2014 − In February 2012, potential Republican presidential candidate Newt Gingrich said he had a plan to reduce the price of a gallon of regular gasoline to $2.50. At that time gas was selling for nearly $4.00 per gallon.

While Newt’s claim seemed like a wild dream, look what’s happening today. Less than six months ago, oil was selling for $107 per barrel and gasoline was about $3.50 per gallon. Today oil has dropped to under $70 per barrel and the current national average price of gasoline at the pump is $2.70 per gallon−and dropping a bit more every day. Did Newt know something we didn’t know?

Gingrich wanted to expand exploration for oil and natural gas in the US by allowing companies to drill on federally owned land, something President Obama will not allow. While many have noted that total US crude oil production was steadily increasing, production on federally owned land was 6% below its level when Barack Obama took office in 2009, according to the nonpartisan Congress Research Service.

Although Newt ultimately did not become the 2008 Republican presidential candidate, and although exploration for fossil fuels on federal land continues to diminish, Newt was right that gasoline prices could decrease to $2.50 per gallon. In fact, the price may now fall further. Even when the economies of Japan, Europe and China return to their average growth rates at some future point, the price of gasoline at the pump will likely stay low.

If current trends continue, oil may fall to under $50 per barrel while gasoline drop to $2.35 per gallon. If a Republican wins the White House in 2016, fuel prices could stay low for some time, since a Republican President would likely permit drilling on federally owned land.

So what will that scenario do for the US economy?

For the most part, the news is all good. Lower prices on products like gasoline that consumers must purchase regardless of price will free up more money for consumers to spend on other goods and services−a situation that has remained relatively stagnant for years. This newly spendable money is likely to pursue long-delayed purchases of consumer goods, which tends to stimulate the general economy in much the same way a tax cut would.

If oil prices fall to under $50 per barrel, the lower prices and increased consumption could add as much as ½% growth to the gross domestic product (GDP). Since we have averaged about 2% annual growth for the past five years, this ½% addition is significant when it comes to increasing domestic business growth back to previously normal levels.

In addition, manufacturing companies and the airline industry will also benefit from lower energy prices and will likely deploy the savings to increase investments and to finance future growth, resulting in a further increase to the GDP. This supply side expansion will also reduce unemployment and help to keep inflation low.

There will also be downward pressure on prices from the demand side as other forms of energy draw consumers away from oil. Efficiencies in both solar and wind power have reduced costs to the point where, even without subsidies, they are increasingly competitive. A new administration in 2016 could also promote the use of clean-burning coal, which would also take some demand away from the oil market.

The downside of the current direction in oil prices is that if prices fall too low, the situation will discourage further exploration, since it may not be profitable below a certain price point. However, due to new cost-effective extracting technologies, most experts estimate that as long as the price of oil remains above $40 per barrel, the exploration of conventional and unconventional oil and gas fields will continue.

Another downside to cheaper oil is that cheap gasoline may encourage people once again to buy gas-guzzling cars. That’s what happened in 2005 when gasoline prices fell significantly. But new, higher fuel economy standards should serve to reduce the number of gas guzzlers on the road.

So it turns out that Newt Gingrich was right. We can have gasoline priced at $2.50 per gallon, and we likely will shortly. But Newt thought he would have to allow drilling on federal land in order to get the price down to the level he had predicted.  As it turns out, the simple operation of market forces proved to be enough. With a new administration in place after the 2016 election, we could see even lower prices.

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