Fuel Prices Are a Problem for Businesses and Consumers—Why Costs Are So High

A sign displays gas prices at a gas station on May 10, 2022 in San Mateo County, California.

Liu Guanguan | China Information Service | Getty Images

Soaring gasoline prices are impossible to miss and at the top of consumers’ minds as billboards advertise gasoline now costing $4, or $5, or even over $6 a gallon at certain places.

With record prices, Americans are immediately feeling the impact at the pumps. But rising fuel prices are also a headwind for the wider economy, beyond just consumers with less money to spend. The rising cost of fuel, especially diesel, means that anything transported by truck, train or boat is affected.

Energy costs have been a major contributor to high inflation figures for decades, as the prices of all kinds of goods and services rise.

“The energy, in a way, is the tail wagging the dog here,” Bob McNally, president of Rapidan Energy Group, said on CNBC’s “Power Lunch” show on Wednesday.

“Diesel is really the economic fuel. It’s the lifeblood of the economy, transportation, electricity in some cases…so it’s really integrated into economic activity and it’s filtered through so many goods and services.”

Why are fuel prices so high?

The spike in gasoline prices is due, in large part, to the spike in oil prices. Russia’s invasion of Ukraine is the latest catalyst to push crude higher, but prices were already on the move before the war.

Even before Covid, energy producers scaled back investments and less profitable projects under pressure from low prices and institutional shareholders demanding higher returns.

Then producers further cut production during the throes of the pandemic, when the need for petroleum products fell off a cliff. People weren’t going anywhere and businesses were closed, so much less fuel was needed. Demand fell so suddenly that West Texas Intermediate crude, the US oil benchmark, briefly traded in negative territory.

Economies have since reopened, manufacturing has resumed, and people are driving and flying again. This led to a sharp increase in demand and an increasingly tight oil market from last fall. In November, President Joe Biden tapped the Strategic Petroleum Reserve in a coordinated effort with other countries, including India and Japan, in a bid to calm prices. But the relief was short-lived.

Russia’s invasion of Ukraine in late February rattled an already fragile energy market.

US oil hit its highest level since 2008 on March 7, topping $130 a barrel. Russia is the world’s largest exporter of oil and products, and the European Union depends on it for natural gas. While the United States, Canada and others banned Russian oil imports shortly after the invasion, the European Union said it could not do so without adverse consequences.

Now the bloc is trying to put in place a sixth round of sanctions against Russia that includes oil, although Hungary is among those pushing back.

Oil has since retreated from its post-invasion highs but remains firmly above $100. To put that number into context, at the start of 2022 a barrel of crude was worth $75, while this time last year prices were closer to $63.

The rapid rise in oil and therefore fuel prices is giving the Biden administration a hard time, which has called on producers to pump more. Oil companies are reluctant to drill after promising shareholders capital discipline, and executives say that even if they wanted to pump in more, they simply couldn’t. They are facing the same problems that exist throughout the economy, including labor shortages and rising prices for parts and raw materials, such as sand, which is essential for the production of Hydraulic fracking.

Oil prices account for more than half of the final cost of a gallon of gasoline, but that’s not the only factor. Taxes, distribution and refining costs also influence prices.

Limited refining capacity is starting to play a bigger role. Refining is the key step that transforms crude oil into petroleum products that consumers and businesses use every day. The amount of oil refiners can process has declined since the pandemic, particularly in the Northeast.

Meanwhile, Russia’s petroleum product exports are being hit with sanctions, leaving Europe to search for other suppliers. Refiners are operating near capacity and crack spreads – the difference between refiners’ cost of oil and the price at which they sell their products – for diesel are now at record highs.

All of this is pushing gasoline prices up. The national average for a gallon of gasoline hit a record $4,589 on Thursday, according to AAA, up from $3,043 at the same time last year. Figures are not adjusted for inflation.

Every state is now averaging over $4 per gallon for the first time, while California’s state average is now over $6.

Diesel prices are also skyrocketing. Retail diesel prices hit an all-time high of $5.577 a gallon on Wednesday, up 76% from a year ago.

According to Yardeni Research, households are now spending $5,000 a year on gasoline, up from $2,800 a year ago.

How do fuel prices affect businesses?

Demand destruction, or the level at which high prices influence consumer behavior, due to soaring fuel prices, may not yet have taken hold on a large scale, but the impacts are rippling through the world. whole economy. Higher prices at the pump not only mean less money spent in consumers’ pockets, but also increased costs for businesses, some or all of which will then be passed on to consumers.

Target is one of the companies struggling with higher costs. Shares of the chain store cratered 25% on Wednesday – the worst day since 1987 – following results from Target, during which it warned of inflationary pressures.

“We did not anticipate the rapid changes we have seen over the past 60 days. We did not anticipate transportation and freight costs to skyrocket as they have as fuel prices reached unprecedented heights,” said Target CEO Brian Cornell. Wednesday during the company’s quarterly earnings call.

He told CNBC that rising fuel and diesel costs will add approximately $1 billion in additional cost in the fiscal year and a “significant increase that [Target] did not anticipate.”

Walmart executives made similar comments. “[F]Fuel costs accelerated during the quarter faster than we could pass them on, creating a timing issue,” Walmart Chairman and CEO Doug McMillon said on the earnings call on Tuesday. retailer in the first quarter. “Fuel grew by more than $160 million for the quarter in the U.S. than we had expected.” McMillon added that during the quarter the company made “progress by adapting prices to rising costs”.

Tractor Supply executives noted that domestic and import freight costs have increased “significantly” over the past year and said they expect those trends to persist through 2022.

The cost of shipping a container overseas has more than doubled from pre-pandemic rates, and the cost of fuel is about one and a half times higher than it was a while ago. even a year,” Amazon noted in its quarterly update.

Monster Beverage executives said the company experienced “significant increases in cost of sales compared to the comparative first quarter of 2021, primarily due to increased freight rates and fuel costs.”

The airline industry is also feeling the impact, as jet fuel prices, particularly on the East Coast, rise.

Southwest Airlines noted that it had seen a “significant increase in market jet fuel prices” over the past quarter, while United Airlines CEO Scott Kirby told CNBC that if current jet fuel prices continued, it would cost the airline $10 billion more than in 2019.

Bob Biesterfeld, CEO of CH Robinson, summed it up. “The challenge ahead of us, however, is really the rising and record high cost of diesel fuel, which is having such a huge impact on the overall price of freight,” he said on CNBC’s “Closing Bell” on Wednesday.

To put the surge into context, he said a carrier will now have to pay almost $1,000 more than last year in fuel costs to move cargo from Los Angeles to the East Coast.

“It’s real inflationary cost pressure,” he said.

Is there relief in sight?

Looking ahead, experts say demand destruction may be the only thing stifling rising gasoline prices.

John Kilduff, partner at Again Capital, said a national average of $5 was expected for the busy driving season between Memorial Day weekend and July 4.

“It seems [the national average] gotta go higher,” he said on CNBC’s “Squawk on the Street” on Wednesday. has more advantages here.”

Kilduff pointed to two key factors driving demand despite high prices: pent-up demand after the pandemic and a strong labor market, which means people will pay what they owe to get to work.

Andy Lipow, president of Lipow Oil Associates, said he expects the national average to peak between $4.60 and $4.65.

He noted that the sell-off in stocks has led to lower gasoline futures prices, which could provide a temporary respite for consumers at the pumps.

But oil is also used in many consumer products, especially plastics, which means that even if gasoline prices drop temporarily, costs across the economy could remain high if oil remains. raised.

Rapidan’s McNally said at this point it would take a recession to get commodity inflation under control. “It’s not a good forecast. But [gas prices] just go higher because there is no sign of real demand capitulating yet…they will go higher until that happens,” he said.

Fuel Prices Are a Problem for Businesses and Consumers—Why Costs Are So High

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