PMC Weekly Review - May 11, 2018

A Macro View: Do higher gas and oil prices signal a “nuclear fallout” of slower future growth?

Memorial Day weekend typically marks a high point in gas prices every year—summer is near, and many of us will be hitting the open roads. Over the last few years, we have enjoyed low prices at the pump, which have provided us with more disposable income—but all this may be ending. As gas and oil prices continue to rise, we may be forced to alter how we drive, spend, and live. 

The recent tax cuts have put more money in our pockets, but higher gas prices facing us this summer will affect our ability to spend that surplus on other goods and services. Although the prices are still nowhere near the peaks we saw in June 2008, when prices averaged $4.00 per gallon, or in May 2011, when average prices were $3.90, we might be headed in that direction. In 2017, the average price per gallon of gas across the country was $2.34 compared with today’s average of $2.82, an increase of more than 20%.1 Over this same period, West Texas Intermediate Oil (WTI) also increased from an average of $51 per barrel to nearly $70 per barrel.2

Geopolitical worries are a significant factor in rising gas and oil prices, as the United States has withdrawn from the Joint Comprehensive Plan of Action (more commonly known as the Iran nuclear deal), and plans on restoring sanctions that target Iran’s energy, financial, and industrial sectors. President Trump’s decision to pull out of the deal can have far-reaching consequences for the oil market, gas prices, and overall relations in the Middle East. Iran is the third-largest oil producer within the Organization of Petroleum Exporting Countries (OPEC), and the sanctions should cause tighter supply by removing as much as one million barrels of Iranian oil per day.3 Furthermore, oil-rich Venezuela’s dramatic cut in production also has impacted prices as the country’s oil output recently fell to its lowest levels in almost 30 years. Venezuela is facing an economic crisis that is getting worse, with no cash for maintenance or investment, a debt crisis, and U.S. sanctions that will only continue to place pressure on their output.4 

Oil supply also has been driven lower due to an OPEC agreement, established in January 2017, to cut oil production. OPEC’s goal in this agreement was to reduce the amount of surplus oil stored around the world, thus increasing the global price of oil. Talks suggest that OPEC may continue with the agreement through 2019, thereby continuing to place pressure on the oil supply and consequently increasing gas prices. OPEC is scheduled to meet on June 20 to decide whether to keep in place the agreement to cut oil production.5 

If it were not for the US shale oil industry’s increased production, we already would likely be facing gasoline and oil prices that are significantly higher than we see today. However, demand has recently outpaced supply, as solid world-wide economic growth has put even more pressure on gas and oil prices. It remains to be seen if these prices will continue on their current upward trajectory, or whether they will fall back to the lower levels that we have grown accustomed to for the last few years. What we do know is that oil price fluctuations have considerable consequences on economic and capital markets activity. In fact, ten of the last eleven post-World War II recessions occurred on the heels of oil price spikes.6 Will rising oil prices be the impetus that finally brings the long-running stock market to its knees? 




Michael Pajak, CAIA
Investment Analyst

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