Higher oil prices likely won't cause consumer spending and gross domestic product (GDP) to decline, Goldman Sachs (GS) analysts said in a recent research note while those at S&P Global think this increase will not last for long.
Key Takeaways
Analysts at Goldman Sachs say a sustained rise in oil prices likely won't cause an economic downturn while those at S&P Global expect oil prices to moderate in the near future.
Goldman analysts said the current rally is small by historical standards and could be offset by falling electricity prices, while energy sector capital expenditures could boost GDP.
Rising oil prices could impact consumers through higher prices at the gas pump.
The U.S. government's ability to influence prices could be less effective now, as reserves at the Strategic Petroleum Reserve (SPR) have dwindled to their lowest in 40 years.
Analysts at the Wall Street giant attributed their forecast to a combination of three factors. They said the rise in oil prices is small from a historical standpoint, with the price of Brent crude—the international benchmark—up by just $20 per barrel since the start of the current rally. By comparison, prices surged by $40 in the first half of 2008, and $45 per barrel in last year's first half.
Second, rising oil prices could be offset by lower electricity prices, thanks to falling prices for coal and natural gas, coupled with higher capital expenditures (CapEx) from energy sector companies, which the analysts estimated could boost GDP by 0.1 percentage points each quarter over the next four.
Lastly, analysts noted the Federal Reserve is unlikely to keep raising interest rates solely due to a rise in oil prices, especially at a time when core inflation and inflation expectations are trending downward. Analysts estimate that the rise in oil prices has already flowed through the Consumer Price Index (CPI), meaning any further increase is unlikely to drive inflation higher.
Oil prices have climbed by more than a third since the end of June, due to a combination of OPEC+ supply cuts, a resilient U.S. economy, and rebounding demand from China after last year's COVID-19 lockdowns hobbled the world's second-biggest economy.
While adverse macroeconomic impacts may be mitigated, higher prices could pressure consumers at the gas pump. The average cost of a gallon of unleaded gas stood at $3.85 on Monday, according to AAA. That's up from $3.54 at the end of June, when the rally began, and compared to $3.71 at the same time last year.
A silver living is that spending on gas now accounts for a smaller share of total household consumption. The energy share of consumption fell to just 4%, on average, in July, with motor fuel at the gas pump accounting for roughly half of that, or just 2.3% of total consumption.
Government's Influence on Prices Could Be Waning
In the past, the U.S. government has tried to mitigate surging oil prices by releasing oil from the Strategic Petroleum Reserve (SPR). However, this could be less effective now as reserves have dwindled to their lowest since 1983, after last year's record drawdowns. While the quantity of oil in the SPR represents just a tiny fraction of the global supply, decisions to draw down or replenish the reserve could at least have a short-term impact on prices.
Respite Around The Corner?
However, not everyone is forecasting persistently higher oil prices ahead.
Jim Burkhard, Vice President and Head of Research for Oil Markets at S&P Global's commodity insights division, said in an email the company expects oil prices to "ease from recent levels as demand begins to seasonally decline," but cautioned that "supply restraint and the ongoing normalization of oil consumption in China will limit the downside."
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Higher oil prices likely won't cause consumer spending
consumer spending
Consumer spending is the total money spent on final goods and services by individuals and households for personal use and enjoyment in an economy. Contemporary measures of consumer spending include all private purchases of durable goods, nondurable goods, and services.
and gross domestic product (GDP) to decline, Goldman Sachs (GS) analysts said in a recent research note while those at S&P Global think this increase will not last for long.
Rising Oil Prices Have Usually Preceded Most Recessions. As the figure shows, nearly all post-World War II recessions in the United States were preceded by, or accompanied by, a sharp increase in energy prices relative to the aggregate price level.
The 2008 financial crisis and the Great Recession that followed had a pronounced negative impact on the oil and gas sector as it led to a steep decline in oil and gas prices and a contraction in credit. The decline in prices resulted in falling revenues for oil and gas companies.
After global growth exceeded expectations in 2023, businesses' perceived probability of a global recession has fallen substantially in 2024, according to Oxford Economics data. Oxford's global risk survey in January showed a recession probability of 7.2% — less than half of what it was in October 2023.
High oil prices can drive job creation and investment as it becomes economically viable for oil companies to exploit higher-cost shale oil deposits. However, high oil prices also hit businesses and consumers with higher transportation and manufacturing costs.
Some suggest it would probably not be just gasoline alone that would send the economy into a tailspin. That said, economists say a recession is indeed possible if fuel prices rise to an even higher level and stay there for an extended period of time.
Rental agents, landlords, and property management companies can thrive during a recession, when renting is likely to become a more appealing housing option.
Because a decline in disposable income affects prices, the prices of essentials, such as food and utilities, often stay the same. In contrast, things considered to be wants instead of needs, such as travel and entertainment, may be more likely to get cheaper.
Historically, the industries considered to be the most defensive and better placed to fare reasonably during recessions are utilities, health care, and consumer staples.
The top five US-based oil and gas companies by market cap, according to S&P Global — ExxonMobil (XOM), Chevron (CVX), ConocoPhillips (CPP), EOG Resources (EOG) and Schlumberger (SLB) — have raked in more than $250 billion in profits between 2021 and 2023.
Like most commodities, the fundamental driver of oil's price is supply and demand in the market. The cost of extracting and producing oil is also an important factor. Oil markets are composed of speculators who are betting on price moves, and hedgers who are limiting risk in the production or consumption of oil.
After finishing 2021 with real GDP growth of 5.6 percent (on a fourth- quarter-over-fourth-quarter basis), real GDP is projected to increase 3.8 percent in 2022 and 2.5 percent in 2023. Real GDP growth is then expected to average 2.0 percent between 2024-2028, and 2.3 percent during 2029-2032.
According to the National Bureau of Economic Research (NBER), the average length of recessions since World War II has been approximately 11 months. But the exact length of a recession is difficult to predict. In general, a recession lasts anywhere from six to 18 months.
Economist Claudia Sahm has shown that when the unemployment rate's three-month average is half a percentage point higher than its 12-month low, the economy is in recession.
Higher oil prices contribute to inflation directly and by increasing the cost of inputs. There was a strong correlation between inflation and oil prices during the 1970s. Oil's potential to stoke inflation has declined as the U.S. economy has become less dependent on it.
Inflation can cause a recession in some instances, such as: If inflation spurs consumers to cut spending too much. Less money in the economy means lower revenues and potentially negative growth for businesses. If the Fed raises interest rates too much to rein in inflation.
There are a variety of reasons recessions take place. Some are associated with sharp changes in the prices of the inputs used in producing goods and services. For example, a steep increase in oil prices can be a harbinger of a recession.
A key benefit to investing directly in oil through futures is the potential for price appreciation. If the price of oil rises, the futures contract holder makes money. These assets can serve as a useful inflation hedge when the economy is running hot.
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