By Cindy Alvarez & Bob Newkirk
“We aren’t addicted to oil, but our cars are.”
– James Woolsey
Roughly 99% of vehicles in the U.S. run on gasoline or diesel fuel. The price of oil used to produce gasoline and other energy products continues to have a significant effect on the U.S. economy, its corporations and your investments. The oil market is truly global, with price changes in Europe and elsewhere directly affecting the market in the United States. While the U.S. has some influence over domestic energy prices, knowledgeable investors pay attention to developments in both the global energy markets and related U.S. policies.
Energy Costs, Inflation and Economic Growth
Overall, in part due to higher prices for oil and gas, the amount consumers are spending on
energy has increased by 10% to 30% over last year.
The most obvious effect of higher oil prices is on the price of gasoline. While it has moderated
recently from highs earlier in the year, the price at the pump is still up an average of $1.50 per
gallon, or about 50%, from two years ago.
The impact of higher energy prices is more significant for lower-income households. According to a 2011 Minneapolis Federal Reserve Bank study, U.S. households with income in the lowest 20% spend more than 14% of their pre-tax income on energy.
Higher oil prices can hurt overall corporate performance, and the performance of their stock prices. When consumers have to spend more on energy, they have less to spend on other goods or services. J.P. Morgan’s 2015 research report, How Falling Gas Prices Fuel the Consumer, estimated that about 80% of a change in gas spending drives changes in spending on other goods and services.
If that discretionary spending declines due to high gas prices, it hurts the economic growth that contributes to business profits. In addition, higher energy costs can drive higher inflation. In a February 2022 article, Oil Price Surge Threatens U.S. Growth, Josh Mitchell in the Wall Street Journal reported that a sustained price of $100 per barrel for oil in 2022 could shrink U.S. gross domestic product – a measure of the size of the economy – by 0.3%. That higher price could also grow inflation by 0.3%, which can also affect investment performance. (For an explanation of why, see Could Inflation Affect My Investments?)
The Global Oil Market Drives the U.S. Market
The price for gasoline is largely driven by the global price for the crude oil used by refineries to produce gas and other petroleum-based products. The most common benchmark for global crude oil prices is “Brent” crude oil. Brent crude is “sweet” or easier to refine, and is produced in the North Sea between Great Britain and Norway, which makes it readily available to ship via oil tanker.
The price in the U.S. for gasoline moves up or down as the price of Brent crude oil moves up or down. This is a very tight relationship. The only significant variation was in March 2020, when demand for gasoline temporarily plummeted due to pandemic-related shutdowns.