September 24, 2023
Energy Prices - Another Siphon on U.S. Consumer Demand?
Energy prices can be volatile, which is why, along with food, they are stripped out of the closely-watched core inflation readings central bankers use in setting policy rates. Of late, they have been on the rise. What might this mean for consumers and for monetary policy in the months ahead?
When the price of Brent Crude passed $90/barrel late last week it seemed to breach a psychological barrier, at least insofar as markets and the business media were concerned. The last time Brent and West Texas Intermediate, the other global benchmark price, were at $90 was in November 2022 when they were both on a downward path off of summer highs in the $130 range.
They appear to be very much on the upswing now.
Before we get to the reasons this might be, let’s start with why it’s important. The chart below shows the annualized month-on-month changes in the energy component (seafoam green) of the U.S. Consumer Price Index, as well as the motor fuels (coral red) sub-component of the energy CPI.
When we talk about oil and energy prices what we are really talking about is gasoline and fuel oil for transport and as feedstock for petrochemical production, hence the inclusion of the motor fuels sub-component above. Oil is only a tiny portion of electricity generation. As of 2022, 4% of the global oil supply was used for electricity and in the U.S. it was less than 1% (and probably nearer to zero than to one).
The current rally in oil prices began after Saudi Arabia and Russia announced they would be extending supply cuts through to the end of the year. The International Energy Agency then forecast a “substantial supply deficit” for the period, noting also that global observed inventories had already fallen to a 13-month low. The U.S. Energy Information Administration recently raised its Q4 price outlook for Brent to $93/barrel for those same reasons. And now investors are betting heavily on further rises, as evidenced by the increase in net long positions in Brent and WTI.
Back to the chart. Month-on-month, the energy component of the CPI rose 5.6% in August. This was the largest increase since June of last year, when it was up 6.9%. Annualized, the August change equates to 92.6%, which we noted last week. The motor fuels sub-component increased 10.7% month-on-month, or 239% annualized. No one is forecasting sustained energy price inflation at 92% or 239%, however. Certainly not us.
But there are potential implications.
One of those is for consumer spending. Historically, demand for gas has been inelastic, meaning it doesn’t adjust in inverse correlation with prices. Americans have to drive, so when gas prices rise, demand changes little. The question is: Do they drive as much as they used to? With seasonally adjusted total vehicle miles driven back to December 2019 levels, the answer appears to be yes, despite concerns coming out of the pandemic that more people working from home would translate into fewer miles driven.
This adds another piece to the case we have been building for an approaching fall-off in what has otherwise been surprisingly resilient consumer demand in the U.S. High interest rates, disappearing savings, falling real disposable incomes, rising credit card debt, the resumption of student loan payments and now the need to spend more on gas. Together, these factors suggest we might be approaching a downturn in personal consumption, which accounts for around 70% of nominal GDP.
As far as the price of oil is concerned, the prospects for near-term relief seem dim, although there is some disagreement. The U.S. Strategic Petroleum Reserve might have been an option for the administration, but it’s been drawn down to its lowest levels since the early 1980s after record releases following the onset of the conflict in Ukraine.
Where does that leave us? Consumer year-ahead inflation expectations just fell to 3.1%, the lowest they’ve been since March 2021. Consumers are not central bankers, however – they don’t differentiate between headline and core prices. If higher gas prices diminish their spending power, that improvement in sentiment might prove transitory, adding to the Fed’s headaches by affecting its target for a soft landing for the economy.
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