Rising Energy Poses Big Inflationary Threat To U.S. Economy
Fears about inflation are rampant in Europe where natural gas and power shortages are colliding with the onset of winter to drive energy prices to record-breaking levels. Mix in the effects of supply chain bottlenecks caused by the global pandemic and you have a dangerous cocktail of rising prices and falling purchasing power of must-have energy products.
And while the situation in the United States is not as bad, consumers and investors can’t afford to be complacent. Wall Street traders are watching what’s happening in Europe and anticipating inflation will continue to rise on these shores, too.
Concerns about the most recent Consumer Price Index (CPI) report put the jitters in traders that knocked the wind out of the sails of the stocks market. The year-over-year CPI rose 5.3 percent over its level last August and the core CPI is up 4 percent over the same period. That’s a slight decrease from where they were in July, but it’s still double the 2 percent inflation rate targeted by the Federal Reserve.
U.S. consumer prices increased at their slowest pace in six months in August, however those figures ignore the volatile food and energy components of the market. Consumers don’t have the luxury of ignoring rising prices for energy commodities like crude oil, natural gas, gasoline, and diesel. The cost of energy impacts prices throughout the supply chain – from production to transportation – and those extra costs ultimately filter down to the consumer at the end of the line.
Benchmark Brent crude oil now trades above $75 a barrel, or more than 45 percent above where it started the year, and analysts warn that a tightening oil market could prompt further gains.
Average U.S. retail gasoline prices are some 50 percent higher than a year ago at $3.19 a gallon, and with crude feedstock costs rising and some refineries still constrained after Hurricane Ida, they could also move higher.
The situation is most alarming in natural gas, which many consumers rely on to power and heat their homes. At over $5 per million Btu, benchmark Henry Hub natural gas prices are more than twice as high as a year ago, at an annualized rate equal to a $109 billion increase to consumers. The Energy Information Administration (EIA) reports that working natural gas stocks are 17 percent lower than a year ago and 7 percent below the five-year average.
Gas shortages in Europe and Asia are drawing more U.S. gas abroad as exports of liquefied natural gas (LNG), exacerbating market tightness here despite America’s vast gas reserves. The EIA says that natural gas exports are up 41 percent from a year ago.
The consultancy S&P Global Platts calculates that Henry Hub prices would have to increase to $10 per million Btu to provide incentive to U.S. producers to fulfill domestic natural gas demand rather supply the export market. At those price levels, which the United States experienced in 2008, would cause demand destruction in the manufacturing sector. Many manufacturers that consume large quantities of natural gas can no longer compete in the market at those prices, which results in a loss of jobs.
Low gas inventories and rising prices are a concern because the United States should now be building stocks for the winter when the heating season creates peak demand. The market is now in what’s known as a “shoulder season” when demand is structurally lower because the market is in between robust summer cooling demand and peak winter heating demand.
Instead, American consumers could be facing an uncomfortable winter if natural gas prices spike at the same time as crude oil and refined products push higher while the economy continues to recover from the pandemic.
It’s a dangerous prospect, particularly for lower income families who are hurt most by rising energy prices. A 50-cent-a-gallon increase in retail gasoline prices may not dent the wallet of wealthier consumers, but it can be incredibly painful for those with lower or fixed incomes.
And there’s another side to inflation in energy that can squeeze consumers. Investors use commodity markets to hedge their inflation risk, meaning they buy oil and gas futures contracts to hedge against the risk of consumer prices rising across the board. This speculative buying can drive up the price of the underlying commodity for consumers.
The Biden administration is understandably worried about rising energy prices but its attempts to blame the oil and gas industry are off base and show a lack of understanding of energy markets.
President Biden recently suggested that something was amiss with gasoline prices and that the White House would examine the practices of market players for speculation. But what the White House will find is merely the forces of supply and demand at work.
Gasoline and diesel demand has returned to pre-pandemic rates in the U.S., as well as in the critical markets of Europe and China. U.S. refiners are working to supply customers both at home and abroad through exports, but Ida temporarily disrupted that effort, and roughly 25 percent of crude and natural gas production from the U.S. Gulf of Mexico were shut for about two weeks after the storm made landfall.
Ida is likely to have long ripple effects on the market for refined products, with some experts estimating at least 30 million barrels of diesel, gasoline, jet fuel and others will go unproduced due to the storm’s impact on refineries.
Typically, higher energy commodity prices would call for greater supply from producers. But these are not ordinary times. Intense environmental, social and governance (ESG) demands on producers have prompted most to stop investing aggressively in growth.
While investors are largely to blame, the Biden administration has also sullied the investment climate for U.S. oil and gas producers with policies aimed at curtailing fossil fuel production to combat climate change.
The decision by Biden to cancel the Keystone XL pipeline project and attempt to halt leasing on federal lands and waters sends a stark message to the industry and its investors.
Democrats’ proposed $3.5 trillion budget reconciliation — which is more than twice the combined budgets of all 50 states — would only exacerbate the inflationary pressures that are already raising prices for American families.
The bill includes several climate initiatives that would punish U.S. oil and gas producers, including a fee on methane emissions and higher taxes and royalties. These higher costs would ultimately be passed on to consumers.
U.S. energy expenditures totaled $1.2 trillion in 2019 and clocked in at a per capita rate of $3,728. This accounted for about 6 percent of gross domestic product, so rising energy prices could have a brutal effect on the economy while it continues its fragile recovery from the pandemic.
Lawmakers should look hard at Europe’s energy crisis before closing the door on the U.S. oil and gas industry, because we could be next unless pragmatism prevails.