The Economic Threat of Higher Oil Prices
The global price of a barrel of crude oil has been climbing over the last several weeks, rising over 20% since early July. That’s good news for oil producers and refiners, but not necessarily for everyone else.1
Oil prices have risen sharply over the past several weeks
Most readers know the obvious drawbacks to higher oil prices, like higher gas prices. But more expensive oil can also drive up the price of food and other goods. If freight haulers are paying more to move goods around the country, the prices of those goods can also go up as companies account for rising input costs. Oil is also used in the production of everything from plastics to fertilizers, impacting the cost of food and other goods and services that exist downstream.
People that are worried about higher oil prices point to a few factors. Higher prices at the pump can dent consumer spending since households spending more on gas have less to spend on other discretionary purchases. Another concern is that higher oil prices are inflationary, which means the Federal Reserve may have no choice but to continue raising rates, in effect tightening monetary policy more than the market is currently expecting. They may also need to leave rates higher for longer.
These are all valid concerns, especially considering the Fed’s decision to pause rate increases at their meeting last week. The Fed set the expectation that more rate increases may be needed, but the market is largely anticipating that the rate hike campaign is drawing to a close. Higher oil prices could complicate this view.
For investors trying to gauge whether higher oil prices pose a meaningful threat to economic growth and market performance, it’s important to give the issue some context.
First is to consider why oil prices have been rising so quickly of late. Supply is playing a key role — Saudi Arabia and Russia announced recently that the production cuts (of a combined 1.3 million barrels a day) scheduled to end in September would be extended to the end of the year. Elsewhere, OPEC+ members have routinely fallen short of production quotas because of the lack of infrastructure, worker strikes (Nigeria), and other bottlenecks.
The demand side of the equation is much less worrisome. The U.S. economy has been growing at a stronger-than-expected clip, which has meant demand for oil has been surprising to the upside. Many economists worry that China’s real estate and consumer-sector woes would dent global demand, but those concerns appear to be slightly overblown (at least for now). According to the International Energy Agency, oil demand reached a record in June, and is expected to reach its highest annual level ever by year-end. A global economy that’s stronger-than-expected is generally not a negative for markets.
There are other reasons not to get too bearish on higher oil. For one, the economy and markets have withstood $100+ in oil before. The chart below shows the global price of Brent Crude and West Texas Intermediate oil, going back to 2000. I’ve circled in green a period of about 4 years when oil prices hovered in the $100 a barrel range, which were also years when the economy grew consistently – albeit modestly – and stocks remained locked in a bull market.
The U.S. economy can withstand higher oil prices
Another reason is that higher oil prices tend to stimulate additional production, as producers are incentivized to bring more supply into the market. Non-OPEC+ oil producers, like the U.S., Canada, and Brazil, respond to market forces – not production quotas – when deciding how much to produce. The U.S. is the world’s largest oil producer, and our country is poised to hit an all-time high in oil production this year, at 12.8 million barrels per day. Canada and Brazil are also pushing production higher, with both countries producing at or near all-time highs.
A final point to make regards the U.S. consumer. No one likes higher gas prices, to be crystal clear. But it’s also true that the average American spends about $150 to $200 a month on gas, with the average American family spending about $5,000 per year. As a percentage of U.S. household monthly income, spending on gas for a dual-income family is usually less than 5% on average. As long as the labor market remains strong and wages keep ticking higher, I’d argue that an incremental increase to monthly spending on gas won’t move the needle too much on overall spending.
Bottom Line for Investors
There’s no argument that higher oil prices are good for the U.S. and the global economy. They’re not. But the flip side of the argument doesn’t work either, where $100 oil is framed as a negative too great for the economy and U.S. consumers to overcome. The reality is that the U.S. economy can withstand higher oil prices – it has many times before – and the Federal Reserve is likely to continue focusing on “core” prices, which exclude the volatile food and energy categories. And while it’s true that households loathe higher prices at the pump, paying more for gas each month may not do much to crimp overall spending, as long as the labor market remains tight.
Disclosure
2 Fred Economic Data. September 20, 2023. https://fred.stlouisfed.org/series/DCOILBRENTEU#
3 Fred Economic Data. September 20, 2023. https://fred.stlouisfed.org/series/DCOILBRENTEU#
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