Will $87 Oil Kill the Rally?

Prices at the pump are near seasonal record highs … oil prices are surging … why higher oil prices aren’t just a problem when filling up your car … but could higher prices actually be good?

Over Labor Day weekend, gasoline prices in Los Angeles where I live hit their highest level since last November. A gallon of regular self-serve gasoline clocked in at $5.39.

The high prices weren’t limited to LA. Across the nation, gas prices have climbed to near-record highs for this late-summer period.

Here’s CNN Business:

Drivers hitting the roads this Labor Day weekend will be greeted by historically high gas prices for this time of the year.

The record-high for gas prices during the week leading up to Labor Day was set in 2012 at $3.84 a gallon, according to a CNN review of federal data that goes back to 1990.

Current prices are just shy of that. The national average for regular gas is $3.83 a gallon as of Thursday, according to AAA.

Behind these elevated gasoline prices are oil prices that have been surging since June

If you haven’t been watching, a barrel of West Texas Intermediate Crude (WTIC) is now up to $87. Brent Crude is above $90.

Source: CNBC

In mid-June, that same barrel of WTIC cost just $67 – that’s a whopping 30% climb in less than three months.

Source: StockCharts.com

This leap is driven by a significant supply/demand imbalance that’s largely been engineered by oil producing countries as they’ve artificially lowered output.

Let’s go to Bloomberg:

Global oil inventories, already near a six-year seasonal low, slumped sharply over [August] with OPEC+ production cuts and resurgent demand starting to affect the supply of crude…

US nationwide inventories have also been steadily falling for months and are now at the lowest since end of 2022 and that of Cushing — the nation’s biggest storage hub — declined the most since 2021.

Yesterday’s headlines from Saudi Arabia will only exacerbate the imbalance

Yesterday, Saudia Arabia announced it will extend its voluntary 1-million-barrel-per-day supply cut through the rest of 2023.

The expectation was cuts would extend for just one month, so committing to cuts through December caught the market by surprise. The price of WTIC jumped nearly 3% in the wake of the news.

Back to Bloomberg:

Riyadh first applied the 1 million-barrels-per-day reduction in July and has since extended it on a monthly basis. The cut adds to 1.66 million barrels per day of other voluntary crude output declines that some members of the Organization of the Petroleum Exporting Countries have put in place until the end of 2024.

Fellow heavyweight oil producer Russia — which leads the contingent that joins OPEC nations in the OPEC+ coalition — also pledged to voluntarily reduce exports by 500,000 barrels per day in August and by 300,000 barrels per day in September.

Legendary investor Louis Navellier is watching this closely. As he points out, although we usually see lower oil prices in the fall, this year could be different.

From yesterday’s Accelerated Profits Flash Alert:

Now, I do want to remind everybody that crude oil demand probably peaked over the weekend…

As the fall approaches, demand starts to go down… So, we do expect demand to moderate.

But refiners are going to have to switch from their summer fuels to winter fuels, which are demanded in many of the blue states.

This switch-over to the winter fuels usually causes inventory to drop, and keeps prices abnormally high…

It’s unusual for crude oil prices to go up in the fall, but that’s what’s happening already.

While this is putting pressure on wallets at the pump, consider the broader impact on consumer prices

If oil prices remain in the mid/upper $80s (or higher), it won’t just hurt when filling up. Oil prices have a huge impact on shipping… trucking… plastic manufacturers…

Take airlines. Jet fuel accounts for between 25% to 30% of an airline’s operating costs. They won’t just eat this 30% surge in oil prices. They’ll pass it along to you when you book that holiday trip.

Just this morning, CNBC featured a story titled “Airlines warn about spike in fuel costs, Southwest narrows revenue outlook.”

Meanwhile, higher oil prices impact all sorts of consumer goods. All the following products are made with oil and/or natural gas. I can all but guarantee that you use at least a handful of these weekly:

• Cameras
• Coffee makers
• Glue
• Golf Balls
• Lipstick
• Plastic toys
• Sunglasses
• Umbrellas

We usually don’t think about how higher oil prices raise the cost of just about everything, not just gasoline. But that’s the reality.

How might higher oil prices impact inflation numbers – and by extension, Fed policy – later this fall?

Oil prices are headed in the wrong direction for a Fed that’s intent on bringing prices down.

From Yahoo! Finance:

Global oil markets have been tightening as demand climbs to record levels and inventories tumble. Even mounting concerns about Chinese economic growth have been unable to prevent a summer rally…

A renewed inflationary spike would squeeze consumers, and risks derailing efforts by central bankers across the globe to quell inflation.

The going narrative is that inflation is all-but vanquished. But a resurgence in oil prices that extends throughout the rest of the year would apply unanticipated upward pressure to inflation.

Now, there’s a logical pushback: “Jeff, the Fed looks primarily at ‘core’ inflation that strips out energy costs. So, higher oil prices would be moot.”

In large part, that’s true. The Fed is less inclined to be swayed by higher oil prices. And I’ll take it one step farther with a curveball you likely wouldn’t expect from me…

Some higher prices at the pump could help the Fed – if they don’t climb too high.

To understand why, consider the real impact of higher oil prices on the U.S. consumer

Sure, higher gas prices impact a monthly budget. But the real hit isn’t financial, it’s psychological.

Plenty of other line items in a family budget have far greater impact on overall economic health than oil/gas prices. But emotionally, few things erode consumer confidence like high gas prices.

Here’s the New York Times making this point roughly a year ago:

Ask Americans their outlook on the country — its future, its economy, its president — and their mood has risen and fallen in surveys this year in striking sync with the price of gas…

It’s of course not the case that fuel prices alone dictate the optimism (or surliness) of the nation. But these patterns suggest that gas, distinct from other things we buy, wields real power over how Americans think about their personal circumstances, the wider economy and even the state of the nation. 

Here are some spending data illustrating this reality from Convenience.org:

A recent survey by NACS found that higher gas prices prompt consumers to reconsider everyday household purchases.

Respondents said they have become more price sensitive when buying groceries (88%) and buying gas (87%), cutting back on snacks and drinks (80%) and dining out less (74%). 

So, higher gas prices have a souring effect on consumer confidence. And by extension, that’s likely to close some wallets.

Up to a point, the Fed would deem that a good thing

For a Fed wanting to bring down demand, some slowdown in consumer spending would be welcomed. It would help the Fed’s fight against inflation – potentially even offsetting an uptick in inflation from higher oil prices.

But too much of a slowdown would be trouble.

With consumer spending driving 70% of our economy, there’s a tipping point at which pessimism and reduced spending risk igniting the recession that so many talking heads now claim is off the table (here, in the Digest, we do not claim that). But we’re getting ahead of ourselves…

For now, keep your eye on one week from today – September 13th. That’s when we’ll get the latest Consumer Price Index report.

Energy accounts for nearly 8% of the index’s weighting, so we’ll be watching to see how the runup in oil prices over the last month has impacted the bottom-line inflation data.

We’ll keep you updated here in the Digest.

Have a good evening,

Jeff Remsburg

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