Consumers take notice as inflation bites and oil prices top $90 a barrel

Oil has climbed primarily due to expectations of tight supply, especially in light of the news coming from the Organization of the Petroleum Exporting Countries about a potential supply shortfall in the fourth quarter, said Katy Kaminski, chief research strategist and portfolio manager at asset manager AlphaSimplex.

In monthly reports released this week, OPEC and the International Energy Agency forecast a fourth-quarter deficit in global oil supplies following decisions by Saudi Arabia and Russia to extend their voluntary crude production cut to the end of the year.

Investors tend to have a bias towards key numbers, so when the price of oil hits $90 or $100, they get worried, said Kaminski. “This is also the range at which we see articles get written, gas prices go up, consumers having to make choices about their consumption, and companies having to decide whether or how they pass on costs.”

The impact of high oil prices will “percolate into different parts of the economy,” as it did back in March and April of last year, though not likely as extreme, she said, referring to the months following the February 2022 start of the Russia-Ukraine war.

“Oil is a good place to look for the start of a cycle, predicting where price inflation will move,” said Kaminski. “We can’t predict how this will end, but high oil prices may challenge the view that inflation will be moving back to target levels.”

The Federal Reserve’s target U.S. inflation rate is 2%, but the yearly rate of inflation moved up to 3.7% in August.

Fuel costs

“Consumers are being impacted by higher energy costs now,” said Brian Milne, product manager, editor and analyst at DTN. “While crude-oil prices closing in on $100 a barrel has more of a psychological effect on most consumers since they don’t buy crude oil, they do feel the anxiety of climbing gasoline prices.”

Regular gasoline at the pump averaged $3.835 a gallon on Friday, up from $3.808 a week ago, and up 15.4 cents from a year ago, according to GasBuddy.

Gasoline prices rival the summer highs when they typically peak, and high gasoline prices harm consumer sentiment, said Milne.

Gasoline prices, however, may ease in the last 100 days of this year, “thanks to cheaper components,” with refiners and blenders able to mix in cheap high octane components like butane into motor fuel, said Tom Kloza, global head of energy analysis at the Oil Price Information Service (OPIS), a Dow Jones company.

Most U.S. states transitioned Friday to higher Reid vapor pressure gasoline, moving away from summer-grade fuels and enabling gasoline blenders to “load up” finished motor fuel with cheap butane, naphtha, and natural gasoline, he explained.

Even so, Kloza points out that U.S. fuel prices at the pump are now more than $1 a gallon higher than they were when the domestic crude oil benchmark first surpassed $90 back in autumn of 2007. “Those gains are largely due to dramatically higher refinery margins as well as more profit for gasoline distributors and retailers,” he said.

As for diesel, average retail prices on Friday were at $4.5515 a gallon, the highest since February, according to data from GasBuddy.

“Rising diesel prices spread through the economy, increasing costs not only for manufactured goods, but also food prices,” said Milne. Rising diesel prices were a key factor in driving inflation higher at the wholesale level in August, he said.

Meanwhile, climbing costs for both labor and jet fuel have pushed airfares higher in the third quarter, Milne said. Travel demand remained strong, but that may change in the fourth quarter, he said.

The average price for jet fuel was at $3.0447 a gallon for the week ended Sept. 8, up 3.3% from a month earlier, according to the International Air Transport Association.

When it comes to diesel and jet fuel, “inflation is really manifesting itself,” said Kloza. U.S. wholesale prices for both of these fuels are up by more than $1 a gallon in the majority of the country, compared with prices on June 30, he said.

“Diesel and jet price inflation is just getting started,” he said.

Potential for higher oil prices

Oil prices, meanwhile, may still have room to climb even higher.

By the end of the year, Saudi Arabia would have withheld more than 180 million barrels of oil from the global market since July, said DTN’s Milne. That’s nearly as much as the U.S. released from the Strategic petroleum Reserve in response to Russia’s invasion of Ukraine in 2022, he said.

Pulling supplies from the SPR helps during market emergencies, but is “not a sustainable path to keeping a market well supplied,” said Milne. “The best response is to allow private industry to respond to high prices by producing more.”

Going into the final quarter of the year, AlphaSimplex’s Kaminski believes there are three big potential tailwinds for oil: an increase in demand from China, a stronger U.S. dollar, and a climb in weather-related demand.

“Weaker-than-expected demand from China may have kept oil prices at bay this year,” she said. If the Chinese economy should make a comeback going into year end, oil prices might continue their rally upwards, putting further pressure on the inflation numbers.”

The dollar, meanwhile, has been staging a recovery from last year and if it continues to strengthen, oil prices will “continue to be even more expensive from a global buyer’s perspective,” Kaminski said.

Also, keep in mind that the fourth quarter is a time when the market often sees weather-related increases in demand for oil, she said. That could drive prices higher, especially if there is a supply shortfall.