New York (CNN Business) – There isn’t much that Joe Biden, Congress or the Federal Reserve can do to lower record gasoline prices, but higher prices can do it for them.
This is because large fluctuations in the prices of a good or service are often caused by an imbalance between supply and demand. And when imbalances cause prices to rise, as oil and gas prices have risen since Russia’s invasion of Ukraine in February, those higher prices can help rebalance supply and demand. How? Causing an increase in supply and/or a decrease in demand.
It will be difficult to increase the energy supply, especially enough to rebalance the markets. It will take several months, possibly years, to significantly increase US refining capacity to keep pace with pre-pandemic levels. And the oil companies seem determined not to flood the market with oil, which could lead to lower prices. Instead, oil companies use their windfall earnings to boost share buybacks or dividends and help boost the price of their shares.
What about reducing demand? There are already indications that this is happening.
“We are definitely seeing demand destruction at gas stations,” said Tom Cluza, global head of energy analysis at OPIS, which tracks gasoline prices and volumes pumped to compile daily price information published by the American Gas Association (AAA).
The amount of gasoline pumped into the country’s 130,000 gas stations fell 7% in the week ending June 11 compared to the same period last year, and 17% compared to the same week in 2019, before the pandemic, according to Ubis data.
Without the higher prices, US consumption would likely be higher. There are 6.5 million more people in jobs than a year ago at this time, according to the Labor Department, and with offices reopening and workers moving again, there should be more demand for gasoline.
But people seem to find ways to drive less: for example, by reducing or taking one trip to run errands, limiting the number of days they go to newly reopened offices, or resorting to public transportation.
There’s enough pent-up demand for vacations that it’s not clear that many people are willing to forgo long-planned trips to avoid paying $5 for fuel. But the end of the travel season this summer may lead to a further decrease in the demand for gasoline and a further fall in prices. Gasoline consumption and prices in the United States tend to decline steadily in the fall and early winter.
“I think consumption will start to feel the effects of higher prices in the third and fourth quarters,” said Robert McNally, president of advisory firm Rapidan Energy Group. “I think we’ll be more in the $4 a gallon range because of that.”
The biggest risk to demand is that high gasoline prices push the country into recession.
Nothing kills demand like a recession that reduces overall economic activity. When people are laid off, there is less need to drive to work and fewer people drive to the store or to other destinations.
The previous record rise in gasoline prices, before the current one, came in July 2008, when the national average was $4.11 a gallon. But the collapse of financial markets and rising unemployment, caused by the bursting of the housing bubble, rather than by the cost of gasoline, quickly made those high gas prices a distant memory.
By the end of 2008, the price of gasoline had fallen 60% to $1.62 a gallon. But cheap gasoline was no consolation for the nearly 3 million people who lost their jobs over those five months, as what started as an ordinary recession turned into a “great recession.”
On Wall Street and on corporate boards, concern is growing that another recession is looming. And there are warnings that consumers’ reaction to gasoline prices could be one of the factors leading to a recession this time around.
Consumer spending in businesses other than gas stations has begun to decline, according to the latest government reading.
Even with lower gas consumption, people have to spend more at gas stations due to the record prices. This in turn means that people have less to spend elsewhere, which is a worrying sign for the economy as a whole, because 70% of the US economy depends on consumer spending.
The United States is only part of the picture. Oil prices depend on trading in global commodity markets. Therefore, global consumption, not just American consumption, is the main driver.
In many parts of the world, especially developing economies, the price is rising faster. This is partly because oil futures prices are in dollars, and a stronger dollar is driving prices up faster in much of the world, said Pavel Molchanov, oil analyst at Raymond James.
“The economies most exposed to risk from $120 a barrel are emerging markets where the local currency is under severe pressure,” Mochanov said. “Think of how painful it is to pay $120 a barrel when someone’s currency is less than ten percent. It just makes it worse.”
So if current oil and gasoline prices cause a worldwide recession, not to mention the US, we expect gasoline prices to drop.
But it won’t necessarily be something you’re happy with.