Rising Oil Prices Could Pose the Latest Threat to the Economy

Oil prices have surged by over 17% since late June, causing transportation costs for both consumers and businesses to rise and unsettling financial markets. On September 27, West Texas Intermediate crude, the U.S. oil price benchmark, surpassed $93 per barrel, reaching its highest point since August 2022, while Brent crude, the global oil benchmark, exceeded $96.1 per barrel.

This increase in oil prices has predictably led to higher gasoline prices. On November 6^th the national average for a gallon of unleaded gas stood at $3.60. California, which consistently has some of the highest gasoline prices, the average price hit $5.89 per gallon.

Several market dynamics have contributed to these fuel price fluctuations in recent months, raising concerns about broader inflation and the nation’s economic prospects.

1. Tight Oil Supplies: Oil prices are closely tied to the delicate balance between global supply and demand. Much of the third quarter’s price surge can be attributed to a combination of record-high global demand and coordinated supply cuts. Saudi Arabia and Russia, on September 5, announced the extension of voluntary production cuts, reducing output by 1.3 million barrels per day, which will continue through the end of 2023. These cuts build upon previous reductions implemented by the Organization of the Petroleum Exporting Countries (OPEC), along with Russia and other allied oil producers (referred to as OPEC+). Altogether, these supply cuts are anticipated to reduce global crude inventories by 3.3 million barrels per day in the fourth quarter of 2023.
2. Evolving OPEC Influence: OPEC, led by Saudi Arabia, has joined forces with OPEC+ countries since 2016 to increase their influence over oil prices. Together, these groups produced approximately 59% of the world’s crude supply in 2022. Nevertheless, due to advancements in shale drilling technology, the United States has doubled its oil production since 2011, surpassing Saudi Arabia and Russia to become the top oil-producing nation in 2018, accounting for 20% of the world’s total production in 2022.
3. Fuel Costs at the Pump: Crude oil constitutes 57% of the overall cost of a gallon of gas in the United States in 2022, with the rest attributed to refining expenses, marketing, distribution, and taxes. Gas prices are also influenced by seasonal shifts in demand, typically climbing during the summer due to increased vacation travel and declining in the fall. In 2023, extreme heat led to reduced refinery capacity in the Southeast, further boosting prices.

It is noteworthy that the national average gas price remains below the record high of $5.02 set in June 2022 when global oil prices surged following the Russia-Ukraine conflict. Additionally, most states switch to a cheaper winter blend by October, which may provide some relief to consumers.

4. S. Drilling and Economic Impact: Gasoline and heating oil are essential expenses for many households, potentially leaving less money for other expenditures. A significant reduction in consumer spending, which constitutes a significant portion of U.S. GDP, could impact economic growth. The relationship between oil prices and economic performance is complex, particularly in the United States, which is considered a “swing producer.” High oil prices can benefit producers, stimulate hiring and drilling, and potentially boost GDP, offsetting negative economic factors. However, with oil prices consistently above $100 per barrel in 2022, companies were hesitant to invest in drilling. Recently, U.S. producers have increased drilling rigs in the shale oil sector, but the extent to which U.S. production will rise and lower prices remains uncertain.
5. Inflation and the Federal Reserve: Elevated fuel costs prompt businesses to decide whether to absorb these expenses, affecting profit margins, or pass them on to consumers, potentially reigniting inflation throughout the economy. Inflation, as measured by the consumer price index (CPI), increased by 0.6% in August and was up 3.7% year-on-year. A significant portion of this monthly increase was attributed to a 10.6% surge in gasoline prices.

To combat inflation, the Federal Reserve has been aggressively raising interest rates to slow economic activity. Paradoxically, the economy has remained robust despite these rate hikes, so higher fuel costs may actually assist the Fed’s efforts to moderate the pace. Nevertheless, the inflationary effects associated with rising oil prices remain a risk that Federal Reserve policymakers must consider when determining the future trajectory of interest rates.

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By: 2 Market Media