Energy price surge will slow down economic expansion | Joel Naroff

The recent jump in energy costs is another example of one of my favorite phrases: “No good economy goes unpunished.”

Gasoline prices are back at $3 for the first time since November 2014 and the impact of the higher cost of energy will be felt not just by those who drive, but also by those who borrow money or run business. In other words, just about everyone.

Boy, how things have changed.

Just more than three years ago, the average cost of gasoline was about $1.80. Now, it is nearly $3. A penny here, a nickel there, and suddenly we are talking real money.

The rise in gasoline prices is occurring, in part, because strong growth in the U.S. economy and the recovery in Europe and other parts of the world are increasing demand for energy.

In addition, the termination of the Iran agreement has exacerbated the price increase. It has created uncertainty about oil supply, and markets don’t react well to uncertainty.

So, how bad will things get? Once we get some clarity on the Iran situation, energy markets should settle down and prices might even fall somewhat.  Still, it is likely that the current, or even higher, price of gasoline could be with us for quite a while.

The rising cost of energy will offset some of the stronger growth created by the tax cuts.

Consumers will pay more for gasoline, oil, natural gas, and electricity — as long as they drive, heat, and/or cool their houses. Gasoline makes up about 4 percent of household budgets, though that differs according to income grouping. According to Morgan Stanley, households in the lowest 20 percent of the income classes spend about 8 percent of their income on gasoline. They could get clobbered.

A rough rule of thumb is that a 1-cent increase in gasoline prices costs consumers $1 billion  in discretionary income. With prices up 50 cents over the year, spending power is down about $50 billion. Not huge, but not small, either.

For commuters, the impact could be significant. According to the U.S. Department of Transportation, the average person drives about 13,500 miles a year. If they get about 20 miles to the gallon, they purchase 675 gallons of gasoline. That means their cost of driving will be up by nearly $350 this year — more if prices rise further. And that is for just one car. Imagine how much more truckers will have to pay!

But, it isn’t just consumers who feel the brunt of the rising energy costs. Businesses and governments will pay more for their utilities and the cost of transporting goods. Energy-intensive businesses could see their operating costs surge.

And let’s not forget about inflation and interest rates.

Energy prices enter directly into the inflation calculations and to the extent they are passed through to the cost of other products, they raise inflation further.

As inflation increases, interest rates rise. The Federal Reserve could hike rates 1 percentage point this year. All those variable-rate loans that are linked to short-term rates will rise accordingly.

The housing market will also be affected. Longer-term rates determine mortgage rates and they are going up. The benchmark 10-year Treasury note hit its highest level in seven years and mortgage rates have increased a half percentage point over the year. All borrowers are facing higher costs.

But there are some silver linings in the rise in energy costs.

The energy sector, which collapsed when prices cratered three years ago, is booming once again. That should offset, at least somewhat, the decline in consumer spending.

The federal government’s ever-increasing mileage standards have translated into much more energy efficiency vehicles, including SUVs. There are not as many gas-guzzlers on the market anymore. Since we need to buy less gas, the impact of rising gas prices is lessened. And if you have an electric car, unless the utility company raises its prices, you could not care less.

Finally, the surge in energy production has made the U.S. nearly energy independent. Now, most of the increased energy spending stays in the United States, rather than being paid to foreign countries or businesses.

There is still a transfer of income, but it is from the energy-consuming regions in the U.S. to the energy-producing regions.

As long as the increase in energy costs doesn’t get out of hand, the expansion will likely be slowed, not killed. But that is little solace to everyone who has to pay more for energy but who gets nothing more in return.