Energy Threat: Could Record-High Gas Prices Derail the Economic Recovery?

Gas prices have risen sharply in recent months. By mid-March, the average price of a gallon of gas was up about 19% from a recent low in December.¹ Meanwhile, the forecast is for prices to rise to record highs by summer, possibly surpassing an average of about $4 per gallon nationwide and reaching $5 in some places.²

But it’s not just drivers who feel the pain at the pump. It’s possible that stubbornly high energy prices could rattle consumer confidence, thwart business growth, and pose a risk to the economic recovery.

Retail gas prices are tied directly to the cost of crude oil — and oil prices (which are traded on world markets) are especially sensitive to geopolitical crises and supply shocks. In fact, skyrocketing gas prices were largely blamed for stifling U.S. economic growth during the first quarter of 2011.³

So far, the recent run-up in gas prices has been only about half as steep as spikes that occurred in 2008 and 2011.⁴

Forces Affecting Prices

Several factors have helped to drive up the price of gas in early 2012.

Globalization. Changes in the balance between global supply and demand generally cause oil prices to move up or down. By January, gas prices were already at the highest level ever for that time of year, primarily because of tight global oil supplies and growing oil consumption in developing nations.

Geopolitics. World oil prices surged in response to tension with Iran and fears that a conflict could potentially restrict future world oil supplies. Iran has threatened to close off the Strait of Hormuz, the Persian Gulf waterway through which about 20% of the world’s oil trade passes.⁵

Shortages. Domestic supply and demand issues can also affect the price of refined gasoline. Additional driving during the spring and summer months typically causes seasonal price increases. More recently, refinery and pipeline closings caused regional distribution problems that may have pushed up prices in some states.⁶

Will Consumers Retreat?

The average American house-hold spends about 3.7% of its income on gasoline.⁷Transportation to and from work or school doesn’t end when gas prices rise, but car owners may drive less often or find cheaper alternatives to offset the cost. Some consumers may curb spending on other goods and services.

Higher fuel costs can also be a major problem for businesses. Some companies might forego investing in equipment or employees, which could slow business growth prospects.

Company leaders must often decide whether to absorb the additional costs or pass them along to customers by raising prices. Either choice could eventually take a toll on a firm’s competitiveness and cut into profits. Furthermore, if a prolonged period of high energy costs results in widespread retail price hikes for many products and services, it could spark a nationwide rise in inflation.

Seeking Relief

U.S. oil production has surged while consumption has fallen to an 11-year low, but these domestic shifts were not able to counter the global forces at work.⁸

If high prices persist, government leaders might consider releasing oil from the Strategic Petroleum Reserve. Even so, an announcement to release inventories might have only a small and temporary effect on gas prices. Last June’s release of 60 million barrels was not enough to meet the world’s energy needs for even one day. Global daily oil consumption is around 85 million barrels.⁹

When global oil prices fall, it might still be weeks before the pressure on drivers’ budgets begins to ease. Oil price spikes appear at the pump almost instantly, but it takes about a month to refine a barrel of crude oil into gasoline — and about the same amount of time for gas prices to follow oil prices downward.

Strong retail sales and employment gains seem to suggest that consumers, businesses, and the broader U.S. economy are bearing higher gas prices fairly well.¹⁰ But that could change if conflict erupts with Iran and world oil supplies are disrupted, or if energy prices continue to rise (or stay elevated for too long) for any reason. The U.S. economic recovery — which finally seems to be gaining momentum — could eventually lose steam.

1, 3–4, 10) The Wall Street Journal, March 19, 2012
2) CNNMoney, January 16, 2012
5–6) CNNMoney, February 29, 2012
7) CNNMoney, March 21, 2012
8) The Wall Street Journal, February 23, 2012
9) MSNMoney, March 15, 2012

The information in this article is not intended as tax or legal advice, and it may not be relied on for the purpose of avoiding any federal tax penalties. You are encouraged to seek tax advice from an independent professional Naperville Tax advisor. The content is derived from sources believed to be accurate. Neither the information presented nor any opinion expressed constitutes a solicitation for the purchase or sale of any security. This material was written and prepared by Emerald. Copyright © 2012 Emerald Connect, Inc.

Thursday, May 3, 2012