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Why Copper and Oil Prices Dictate Economic Expansion and Contraction

Updated: Jun 21, 2024 | Published: Jun 21, 2024
Verified Investing
By Verified Investing
Why Copper and Oil Prices Dictate Economic Expansion and Contraction

While the strength of the global economy can dictate the price of oil and copper, the reverse is also true. Due to their pervasive influence, copper and oil prices can impact the economy for better or worse. Their influence in supporting or depressing the economy is most often caused by an imbalance in supply and demand.

Oil Supply And Demand

The Arab Oil Embargo of 1973 vividly illustrates the power that geopolitics can play in oil prices and how those high prices affected nearly every part of the economy. Conversely, the shale oil boom of the 2010s made the US a top oil producer and depressed prices below the cost of production for traditional oil exporters like OPEC.

How Oil Causes Economic Expansion

Low oil prices are a broad-based economic stimulant. The Dallas Fed estimates that the shale oil boom contributed as much as 1% to GDP between 2010 and 2015. Low oil prices generated higher employment and created greater economic activity.

The effects of cheap oil prices are most evident in transportation costs. Lower trucking, rail, and air freight costs reduce expenses for manufacturers and retailers. Lower fuel prices mean cheaper airfares, which encourages more people to take vacations and stimulates the economy.

Cheap oil prices can reduce the retail costs of a wide range of goods. Increased consumer discretionary income stimulates the economy due to the large influence consumer spending has on GDP. This also increases labor demand, which adds more workers to the economy, boosting consumer demand even more.

Low oil prices also help control costs for energy generation and petrochemical manufacturers and improve refiners' profit margins. Cheap oil reduces the cost of inputs for manufacturing, especially in petrochemical production. Oil refiners, in particular, see lower expenses and greater margins.

How Oil Causes Economic Contraction

High oil prices affect nearly all aspects of the economy. They mean more expensive petrochemical products and narrower refiner profit margins. Higher transport costs increase retailer expenses and the cost of inputs for manufacturers. This increases wholesale prices and depresses demand, as shown by a rise in the Producer Price Index.

This decrease in demand results in layoffs, increasing unemployment, and depressing consumer spending, which in turn drags on the economy, further reducing wholesale demand. In 2022 testimony to the Senate Banking Committee, Federal Reserve Chairman Jerome Powell said that every $10 increase in the price of oil raises inflation by 0.2% and sets back economic growth by 0.1%

Higher oil prices mean higher fertilizer costs, diesel prices, and freight charges for farmers to get their crops to market, raising food costs. Higher oil prices result in higher gasoline and electricity costs, which also reduces households' discretionary income. This hits the entertainment and leisure industries particularly hard, as it means fewer vacations, airline flights, and dining out. This can cause airline, hotel, and restaurant layoffs.

Copper Supply And Demand

Financial analysts have nicknamed copper “Dr. Copper” for its usefulness as a leading economic indicator. However, copper has as much power to affect the economy as the economy has to affect copper prices. This power will only increase in the future as decarbonization efforts and electric vehicle adoption accelerate.

As a point of reference, the average EV contains more than 53 kg (117 lb) of copper, compared to ~22 kg (50 lb) for ICE vehicles. Copper for charging stations and upgraded power lines to service them add more copper demand. Rebuilding the national power grid will be an enormous drain on copper supply.

Copper is far more susceptible to supply shocks than oil. Natural disasters such as floods can close a copper mine for an extended length of time, for instance. Labor strikes and protests are more common causes of copper mine closure than natural disasters. Regulatory changes in host countries can curtail or even halt copper mine production, which can cause prices to spike and suppress economies across the globe

How Copper Causes Economic Expansion

Copper prices have far-ranging effects on the economy. They are most influential in manufacturing and construction. Lower copper prices promote economic expansion by making building construction cheaper by reducing the cost of wiring, plumbing, and air conditioning. This allows homebuilders to sell houses for less, making homeownership more affordable.

More houses built and more people owning homes increase demand for household appliances, which use a lot of copper. Cheaper wiring and electric motors also help factories by making it cheaper to produce things like cars and electronics. This lowers the overall cost of goods, which helps keep prices stable. As a result, more jobs are created, which boosts the economy even more.

How Copper Causes Economic Contraction

Higher copper prices result in more expensive wiring, electric motors, and electronics. Copper’s wide reach in the manufacturing sector means that higher prices increase the cost of inputs across many industries, increasing wholesale inflation. These higher costs are eventually passed on to the consumer, shrinking their discretionary spending.

Higher wiring and piping costs weigh on homebuilders’ margins, forcing them to raise prices. This reduces home sales, which results in layoffs. These layoffs affect other industries that rely on homebuilding to generate sales. That decreased demand can cause layoffs in everything from furniture stores to appliance manufacturers and lumber companies.