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Unlike other commodities, we are constantly reminded of the direction in which the price of oil is headed when we fill up our gas tanks (for those of us who are still driving combustion-engine automobiles). Higher oil prices have a direct effect on our personal budgets and can be a source of financial anxiety when the oil price climbs quickly.

The chart below illustrates the recent oil price climb – up more than 25% during the last three months, which has pushed the price of gas at the pump to well over $4.25 per gallon, for mid-grade fuel, in Massachusetts.

The recent oil price climb may be acting as an anxiety accelerant for some, so taking a closer look at oil market dynamics might help alleviate these concerns. The information presented below comes by way of Clearnomics, an economic research firm.

Rising energy prices are a direct burden on consumers and businesses who spend more on gasoline and other fuels, putting upward pressure on headline inflation. This also indirectly raises prices on all goods and services as production and transportation costs rise, potentially impacting core inflation.

Thus, higher oil prices effectively function as a tax which can slow economic growth and impact corporate profitability.

Why have oil prices risen in recent months?

First, the U.S. economy has been much steadier than expected. Weakness in oil prices earlier this year partly reflected fears around an imminent recession. The fact that a recession has not materialized has helped to propel oil prices higher.

Second, Saudi Arabia and Russia recently announced that oil production cuts of 1.3 million barrels per day would be extended until December. This amounts to 1.3% of global production – not an insignificant sum – and adds to previous cuts.

The two countries are among the largest in OPEC+ and have led other cuts in order to prop up oil prices, as well as in response to slower GDP growth and weakness in China. Some economists estimate that this could result in a global deficit of more than 1.5 million barrels per day in the fourth quarter of 2023.

It’s important to maintain perspective around these cuts. The relevance of OPEC as a price-setting cartel has declined over the past decade, partly because cuts by each country are voluntary and difficult to enforce, and because the U.S. has become the top producer of oil in the world.

U.S. oil production is nearly back to its pre-pandemic level of 13 million barrels per day. While there are many nuances in terms of the types of oil produced and consumed in the U.S., Europe, and elsewhere, the fact that the U.S. has been a “swing producer” has shifted the dynamics of the energy markets considerably.

Another tailwind for oil prices is declining oil inventories. For instance, the Strategic Petroleum Reserve (SPR), a large emergency supply of oil in the US, is at its lowest level since the mid-1980s.

This is primarily because oil was drawn from the SPR to offset high prices last year when gasoline was averaging more than $5 per gallon nationwide. The federal government would need to purchase 376 million barrels of oil to restore the SPR to its 2010 peak level. While there is no set timeline for doing so, this deficit naturally places upward pressure on oil prices.

So it seems like events are conspiring to keep the price of oil higher for longer. How worried should we be about higher oil prices?

According to David Kelly, Chief Global Strategist at JP Morgan Asset Management, investors should probably not worry too much about the recent spike in oil.”

Kelly, who presents his research team’s findings frequently to the advisor community, contends that, barring some further shock, there should be limited upside to energy prices from here.

The main reason: signs of slower economic activity around the world, according to JP Morgan. The global composite purchasing managers index (calculated from regular surveys filled out by big businesses) hit its lowest level in seven months in August, with outright declines in manufacturing and a moderation in services growth.

Both China and Europe are seeing very sluggish growth, offsetting strength in India and Japan. And JP Morgan is expecting the pace of economic growth to slow in the US as we move into 2024. All of this should dampen the demand for oil and gas, as should longer-term investment in energy transition.

So for those among us who experience oil-related anxiety, taking a few deep breaths, and anticipating less acute pressure on oil-market dynamics in the months ahead, may help.