When you read the news these days, you probably see a lot of doomsday stories about gas prices.
And it's no wonder — gas prices have recently hit record levels in Europe and the U.S., making us all feel ripped off every time we get to the gas station.
For example, in the U.S., a gallon of diesel is now selling for an average of $5.19, up from $3.61 in January. Meanwhile, in Germany, the price has shot up to around 2.15 euros a liter, from €1.66 at the end of February.
A worrying price increase which clearly signals that inflation, already high, might go higher still.
In this article we explain:
- What pushes gas prices up.
- How much higher gas prices affect inflation.
Why are gas prices spiking?
Well, for the most part, three major issues are to blame for today’s stratospheric gas prices:
- Covid-19 pandemic (duh!)
- Cuts to oil production
- The war in Ukraine
Let’s look at each of them in more detail.
Covid-19 pandemic messed up the global oil market
Soaring gas prices certainly have their root in the COVID-19 pandemic.
Here’s why:
- When the pandemic first hit the world, demand for gas dropped as people chose to shelter at home during nationwide lockdowns. For example, a typical driver in the U.S. cut their driving in half when the pandemic started, according to AAA (American Automobile Association). As a result, such a sharp decline in demand caused gas prices to plunge.
- But as the global economy recovered and vaccines rolled out, making us all feel safer about traveling and shopping, people resumed driving. Naturally, with demand rising, gas prices also started to move upwards.
- But now we’re left with oil demand significantly outstripping its supply, and it looks like there’s little promise of relief in the near future.
Cuts to oil production make gas prices stay high
When demand for gas and oil dropped during the pandemic, OPEC and other oil-producing countries such as Russia started reducing their oil production.
They slashed it by an unprecedented 10 million barrels, which makes up about 10% of the global supply. And as we know, a decline in production decreases overall supply, pushing the price of oil up.
Ban on Russian oil will most likely make the gas price situation much worse
Russia is the world’s third-biggest oil and gas producer, and any disruptions will have a major impact on prices — disruptions we’re seeing today:
The price of oil on international markets surged above $100 a barrel for the first time since 2014 because Russia’s invasion of Ukraine snarled resource exports from the region.
The decision of some Western nations to ban Russian oil caused another spike in prices, with some analysts warning that, in the worst-case scenario, oil prices could hit $200.
Meanwhile, Russia warned that $300 oil prices could be on the way, depending on what Europe and the U.S. will do with sanctions.
And while it will certainly have other major effects on the global economy, it also means one thing:
There’s little hope that high global inflation is going to slow down any time soon.
What will high oil prices do to inflation?
To put it shortly, the surge in gas prices is going to keep inflation higher for longer than expected, simply because high gas prices are one of the major factors driving inflation.
What is the relationship between inflation and gas prices?
Higher oil prices directly contribute to inflation, which means that a very significant rise in oil prices (which is the case today) will feed through into higher inflation.
For example, since crude oil is a key ingredient in petrochemicals used to make plastic, pricier oil will affect the prices of some products made with plastic.
What are analysts predicting?
- Joe Brusuelas, Chief Economist at accounting and consulting firm RSM, says the war in Ukraine could push inflation to 10% year over year, with gas prices among the biggest contributors.
- Alan Detmeister, an economist at UBS, thinks that oil at $120 per barrel could mean U.S. inflation hitting 9% in the coming months.
And, as a rule of thumb, every $10 per barrel increase in the oil price raises inflation by 0.2% and sets back economic growth 0.1%. At least that’s what Fed chair Jerome Powell has said.
But if sky-high gas prices persist, they could significantly impact U.S. and E.U. economies, leading to weakening consumer demand for all types of products.
Simply because people will try to tighten their belts to offset higher prices for their daily commutes.
When will gas prices go down?
As Alan Detmeister puts it, “It becomes a question of: How long do oil prices, natural gas wholesale prices stay elevated? That’s anybody’s guess.”
But many analysts predict they are going to stay elevated at least during the summer.
And the potential impact is so great that we are seeing a growing number of forecasts for recession and stagflation (a period when slow economic growth coincides with rising inflation) in Europe and the U.S.
For example, Goldman Sachs sees a 35% risk of recession in the U.S. in 2022, up from just 10% last year. Meanwhile, former European Central Bank official, Otmar Issing, has warned that stagflation is now “the biggest risk” facing the global economy.
What can you do right now to deal with higher gas prices and inflation?
If the forecasts for stagflation and recession are true, and if you want to be prepared for whatever the future has in store, there are a few things you could do right now:
- For starters, you can change your driving habits that cause you to keep going to the gas station, and therefore spending more money.
- Plan when you get fill-ups by following gas prices and avoiding the rising prices whenever possible.
- Set aside some money in your rainy day a.k.a emergency fund (if you haven’t done so already).
- Start saving in gold, a traditional hedge against inflation which holds its value when the economy goes down and inflation concerns increase.
As for us, we’ll keep our finger on the pulse of inflation and gas prices to see how they can affect your investments and precious metals savings in the future.