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IMA Energy & Environment Blog

How the Economy is Tied to Energy

by Ed Fortunato

Constellation is an IMA Member

Constellation market analysts regularly monitor the macroeconomic factors that have an impact on energy, such as the gross domestic product (GDP), industrial production (IP), unemployment rates, auto and trade sales, and government budgets and the trade deficit.

The acronyms we study measure economic activity, which rolls into things like energy demand and therefore, price. For example, we analyze:

  • Gross domestic product or GDP is a sum of all the transactions and measures if these transactions are growing or shrinking. Interest rates and the relationship between short-term and long-term interest rates measure the availability of credit in the system, as the Federal Reserve System is easing or tightening monetary policy.
  • Industrial production or IP measures the increase or decrease in industrial activities. For example, is it growing or shrinking? If it’s growing, will it translate to more jobs, a growing economy, etc.?
  • Talking about jobs, jobless claims are the closest thing to a real time estimate of economic activity. Increasing jobs equals increasing economic activity and income (i.e., you need people to provide goods and services) and the same goes for decreases.
  • We look at auto and home sales because those are the biggest purchases people generally make. They take credit, jobs, etc., to make those purchases happen. Think of the economic activity around a house purchase – such as paint, furniture, credit, brokers, etc.
  • The trade deficit measures the amount of money leaving or coming into the economy, whereas government budgets measure the amount of money that is going to be spent in the coming year.

Economic Activity Affects Energy Demand & Prices

Economic factors – like the above – are impacted by many things, one being demand, and demand is linked to economic activities (i.e., the making, purchasing and selling of services and goods). Strong economic activity increases demand and energy prices follow, and the opposite is also true, so a knowledge and understanding of the status of the economy is essential for understanding the energy markets.

Recent news headlines illustrate the impact economic activity has on demand and prices. Headlines include factory output in the European Union fell in March at the fastest pace in six years, while U.S. manufacturing activity slid to its lowest level in almost two years. This news sent equity markets lower and oil prices lower as traders were concerned about a pending global slowdown, which would reduce the demand for energy.

The Purchasing Manager’s Index (PMI), which is used to measure current economic health for manufacturing and service sectors, is analyzed by energy market analysts and includes survey areas, such new orders, inventory levels, production, supplier deliveries and employment. The index is an indicator of future manufacturing activity, which is energy-intensive in nature. For example, if credit tightens and automotive plants, which require large amounts of energy, reduce output by one million cars annually, then that can have an impact on industrial energy demand and reduce energy prices.

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