For a brief period in the 2010s, high oil prices meant good news for the U.S. economy. Now, they are once again a threat to growth.
With prices topping $100 a barrel for the first time in nearly eight years, the commodity is set to squeeze American households, push up inflation, dent the economic recovery and create a new headache for the Federal Reserve as it moves to raise interest rates.
Brent crude, the international oil benchmark, traded above $100 per barrel Thursday morning. Futures for West Texas Intermediate, the main grade of U.S. crude, topped $96 per barrel late Wednesday, putting them up 28% this year and 52% over the past 12 months. The benchmark, which briefly had a value of less than zero after crashing in spring 2020 as the pandemic unfolded, is now at its highest level since 2014
The rise is being driven by strengthening global demand as economies reopen and recover from the pandemic; low inventories as oil producers struggle to boost output for a range of reasons; and fears of a disruption tied to Russia’s attack on Ukraine.
Few economists say the U.S. is in danger of recession because of high oil prices. But many expect U.S. growth, which already appears to have lost momentum this year because of the Omicron variant of Covid-19, to slow further if prices continue to increase.
“The economic costs increase the higher oil prices rise,” said Mark Zandi, chief economist at Moody’s Analytics. He estimates that oil at $100 a barrel would subtract a 10th of a percentage point from annual growth in the second quarter and half a percentage point in the third quarter.
The U.S. had since the 1970s usually been a net oil importer, which meant a higher oil price acted as a tax that funneled American consumers’ dollars to foreign exporters.
That began to change about a decade ago when domestic producers used new drilling techniques to release a flood of oil from shale formations. The techniques enabled firms to boost output by millions of barrels a day, drilling in places such as North Dakota, Texas and New Mexico. By 2018, the U.S. had become the world’s biggest oil producer. In 2019, it became a net exporter of crude and petroleum products, meaning it exported more than it imported.
During the shale boom, companies drilled aggressively, creating jobs and kick-starting economic activity throughout those regions. Higher prices enriched investors and encouraged additional drilling and investment, offsetting the negative effects from higher gasoline prices on consumers.
Today is different. U.S. companies and their investors are reluctant to drill too much, too quickly after an oil-market crash starting in 2014 that caused prices to fall below the level needed for many U.S. wells to turn a profit. Now, companies and investors take a longer-term approach to drilling, resisting the urge to respond hastily to a surge in prices, analysts say. Oil output in the U.S. is failing to keep up with demand as a result.
“In the teens, big oil-price increases had a big positive effect—shale companies had access to finance and encouragement from investors to ramp up spending on oil and gas exploration,” said Vincent Reinhart, chief economist at BNY Mellon Investment Management firms Dreyfus and Mellon. “We’ll see some of that [now]. But it’s a net negative effect on aggregate demand. It’s hard on consumers.”
Consumer spending represents about two-thirds of U.S. gross domestic product. Higher oil prices typically lead consumers to spend more on gasoline and home heating oil, money they would otherwise spend on other goods and services, sapping economic activity.
If oil stays at $100 this year, U.S. households on average would spend $750 more on energy than they did last year, said Gregory Daco, chief economist at consulting firm EY-Parthenon. He estimates that the higher prices would reduce GDP growth by about 0.3 percentage point in 2022—“not insignificant in the context of an economy already being weighed down by a higher inflation environment,” Mr. Daco said
American households devoted nearly 4% of their living costs to gasoline in December, according to the Labor Department’s consumer-price index. Gasoline prices are one of the biggest drivers of inflation over the past year. Overall prices rose 7.5% in January from a year earlier, the biggest increase since 1982. Roughly a sixth of that increase—or 1.2 percentage points—resulted from higher gasoline prices. A sustained price of $100 for a barrel of oil would push up the overall inflation rate by 0.3 percentage point a year later, Mr. Zandi said.