Higher Fuel Prices Could End Low Inflation

Brent crude futures increased 15% yesterday, which was one of the largest single-day jumps in history. The decline in Saudi production due to the Saturday attack on one of the world’s largest oil processing facilities amounts to an estimated 5% of the world’s oil supply.

In the U.S., gas prices increased yesterday, but only $0.03 or 1.1% according to AAA’s daily national gauge of regular unleaded. Yesterday’s average price nationally was $2.59, which remains almost 26 cents less than the average price a year ago.

This year’s story of low inflation has largely been driven by lower gas prices. Coupled with earnings growth, workers have enjoyed strong real earning gains, meaning earnings are growing faster than inflation, so more is left over.

One of the main reasons why Americans have benefited from lower gas prices is related to the growth in U.S. oil production brought on by fracking. The U.S. is now the world’s largest producer of oil, so we are less dependent on oil from Saudi Arabia.

Also helping us this year, our refineries have so far avoided any disruptions from hurricanes, which can often cause production problems and gas price increases in the late summer and fall.

It is unclear how long the Saudi production will be limited, as reports indicate repairs can be made relatively quickly, or if the attack could lead to further conflict and unrest in the Middle East. U.S. gasoline futures increased 13% yesterday, which would suggest that prices at the pump could move on average about 30 cents from where they were this weekend prior to the attack. Even with such an increase, we’d essentially be right where we were last fall.

Oil and gas futures are both trending back down so far today, demonstrating the volatily of the market and how quickly prices at the pump can move.

While we could see prices move higher with more unrest, it’s likely this won’t be a major blow to consumers or to the U.S. economy. An increase of $0.30 per gallon will cost the average driver about $15 a month relative to what it has been costing to fuel up this summer. We were spending more last year. Yes, the U.S. consumer is clearly obsessed with larger, less-efficient trucks and SUVs, but the penalty for driving them is less pronounced now than it was a decade ago as all vehicles are more efficient, particularly popular SUVs.

If prices indeed remain at the projected increase level, we’ll lose the disinflation benefit of lower fuel costs. Ironically, that will push overall inflation into the target range that the Fed has been asking for.

Couple higher energy costs with the high likelihood of the Fed cutting rates tomorrow amidst an ongoing trade war, inflation may suddenly become more of a worry.