Joe Weisenthal of Business Insider posted a good rule of thumb today that helps quantify the impact of rising oil prices on the US economy. He posts a note from Deutsche Bank that says:

“According to our analysis, a $10 increase in oil prices translates into roughly a 25 cent increase in retail gasoline prices.  Every one penny increase in gasoline is then worth about $1 billion in household energy consumption.  (In decimal terms, it is actually $1.4 billion.) Therefore, a sustained $10 increase in oil prices translates into $25 billion in additional household energy spending.  Assuming this price rise crowds out spending elsewhere in the economy, effectively acting as a tax, means that a sustained $10 rise in oil prices reduces annual real GDP growth by 0.2%.”

Of course, oil and gasoline prices don’t move perfectly in tandem and the gas market can often work with a lag.  For instance, the average national gasoline price is up 21% since September, however, West Texas Crude is up 35%.  So the above math doesn’t compute perfectly.  If we just take out the following we can begin to grasp how much the increase in gasoline is impacting the consumer:

“Every one penny increase in gasoline is then worth about $1 billion in household energy consumption.  (In decimal terms, it is actually $1.4 billion.)”

So, the 21% gas price increase since September has cost the US consumer an extra ~$75B.  It’s not surprising that we have seen some signs of weakness in the consumer in the early portion of this year.  The bad outcome is if we continue to see gasoline prices surge into the seasonally strong summer driving season.  If gasoline prices were to average $3.75 by this summer it would be the equivalent of wiping out the entire tax cut that was recently passed.  If prices were to surge back to their 2008 highs it would be the equivalent of a $182B tax on the consumer since QE2 began.

Even worse are the unquantifiable effects.  How much does surging gasoline prices alter consumer behavior?  How much does oil increase the cost of other products?  Can these costs be passed?  How does this potential margin squeeze influence hiring trends?  No one can really know the extent to which rising oil & gas prices detract from overall economic growth and consumer behavior.  One thing we can confirm is that the baseline scenario above amounts to what is effectively a massive tax increase.  With a weak consumer we can be nearly certain that this tax will be multiplied through corporate America in the form of margin compression as companies fail to fully pass along any cost increases due to rising oil prices.

In sum, while this isn’t a fatal blow to the economy it certainly doesn’t help the overleveraged and underemployed US consumer.   It might not be enough to tip the US economy into recession, but it certainly doesn’t help the tepid growth outlook.


Got a comment or question about this post? Feel free to use the Ask Cullen section, leave a comment in the forum or send me a message on Twitter.

Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.

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  • AK

    Yes, Bernanke is taking care of his bankers buddies at the cost of squeezing main street. I’ve never seen an economist claiming equities providing a “wealth-effect”. What “wealth-effect” is he talking about when I’m struggling to keep my job. There is no cash-inflow when stock prices or house prices go up. But my cash-outflow is higher when I pay higher prices on food, gas, and rent.

    I think this “increase in stock price as wealth-effect” is a code-word “let us squeeze the average guy on main street so that my banker and the super-rich friends can hoard more cash in their accounts”. I think the only main street industry that is benefiting from QE2 is prostitution. All these super-rich bankers now have more money to spend on thier call-girls.

  • goodfriend

    Nice post still those figures are on a time basis which i suspect is yearly but i am not sure. Anyway price has to remain 10$ higher during the length of time i mentionned to have the effect they computed on GDP.

    My point is that if the spike we are seeing is temporary the effect will not be so pronounced.

  • Mannyvelo

    Regarding consumer behavior, it’s not the price of gas that affects it, it’s the change in the price of gas. With the drastic change we are having, consumer behavior is really in for a shock.

  • Derfem

    Wealth-effect for those who live on pension-funds or stock(-option)-value when they retire. Without wealth effect for those, they will need food tickets too. Moreover, without wealth effect, they will sell more shares to have money-back, reinforcing the down trend in stocks.

    I not mean I support Bernanke action, but there is a wealth effect for those ones.

  • JR

    I was in Los Gatos CA yesterday. $4.19 for premium at a Shell station. The funny thing is no one is really talking about gas prices unlike the spike in 2008.

  • Mike J

    Thanks for the analysis of the impact on PCE.

    What you didn’t consider is the impact on net exports. Today’s revision in Q4 GDP highlighted net exports impact on GDP was 3.5% of the 2.8% growth.

    The rise in oil prices will have a direct effect on the import/export costs of goods and will also reduce foreign end demand.

  • quark

    I rarely see a linear correlation between of the spread between a barrel of oil and the retail price at the pump…put a refinery online, shut a refinery down for maintenance, oil companies need more cash for dividends, whatever. It’s a frik’n oligopoly that has control over a primary national defense and Republicans are o’k with cutting the budgets of government institutions that conduct research into alternative energy resources.

    A nations financial markets are truly a reflection of the mental state of a nation and this nation is NUTS!

  • Huckleberry

    Wonder what Iraqi Freedom cost US households in terms of energy consumption these past years… it is not the only factor in oil prices, but I wonder how one would go about trying to tease it out.

  • http://www.pragcap.com Cullen Roche

    Good point. Thanks Mike.

  • http://www.pragcap.com Cullen Roche

    My local gas prices in San Diego are up about 20 cents this week. The guy changing the gas prices is a busy man these days. Last I saw was 3.65. Might be 3.70 by now. Chevron somehow gets off selling the $4+ stuff in CA…..

  • http://blogfirstrider.blogspot.com/ first

    If it was that simple oil companies would much prefer investing in alternative energies than spending billions drilling six miles down or sharing there gains with dictators. You can bet that when it makes economical sense they will.

  • Silalus

    That’s a good point, but it ignores the issue of core competency. Alternative energy research isn’t the core competency of established energy companies and they have little competitive advantage for it- but they DO have competitive advantage for drilling six miles down in the form of expertise, brand, political partnerships, and economy of scale.

    Sure a breakthrow that they manage to produce and control would be a huge advantage, but overall I’d imagine promising research by any external companies would be a top item under the first “T” on their SWOTT analyses.

  • quark

    Innovation rarely originates from an incumbent where the product is in it’s ‘milking the cow’ stage. If it were up to AT&T we’d still be using the telegraph, if it were up to IBM we wouldn’t have a pc, if it were up to Microsoft we wouldn’t have a search engine, if freedom had been left to men in government there would be no women in government and this would still be a serf society…OH I guess as far as economic order we are a serf society and if the middle class were to take to the streets our US troops would be clearing the streets.

    Large Corporations are the new medieval aristocracy.

  • Ashpelham

    The price of oil has been an interrupted curve for about 7 years now. I can track the craziness in oil prices back to early 2004. Crude was stuck in a narrow range for a while, barely ever getting above 40.00bbl. 2004 gave us $60.00 bbl. 2005 and Katrina gave us 80-90bbl. 2006 and 2007 were fairly uneventful, aside from the usual summertime rape we get. Pardon the expression.

    But 2008 put it out there for everyone to see how hurtful it can really be. I contend until I die that 140.00 oil threw the US over the cliff. We found out just how dependent we really were, and how everything is impacted by it. And the worst of all is that it gave American companies an excuse to cull the labor force in this country, move the work overseas, or just double the output of workers.

    I could go on, but my bitterness towards the turn of events in this country since the “election” of GW Bush in 2000 is growing ever day. I can’t hide it, and I won’t. The proper way to acheive change is to park the cars, get out, stand beside them, and demand gasoline prices to be lowered back to a reasonable level that is commisurate with demand/supply numbers. What’s the number? Ask the gas station owners. They will tell you when the price is too low, when they have to shut the doors and turn in the keys. 3.25-3.50-4.00 is criminal.

    Alas, America is too “civilized” for real, changing revolt. No. We’re too focus on the latest Apple gadget and who won American Idol. One way ticket to a deserted island that food can be grown on please?

  • http://exertia.wordpress.com/ exertia

    Very imp. point as crude price rises eat much more into the wallet of people in the emerging countries and other poorer countries by directly leading to transport and food-price inflation.

    A lot of recent S&P 500 profits and revenue growth have been coming in from the rest of the world, hence magnifying the impact.

  • D

    … If those prices are sustained. Temporarily supporting higher equity prices with an inflow of speculative money does nothing as we will likely soon learn.

  • Mediocritas

    Hi Ash,

    No dispute here. $140 oil was the spark that lit the fire. Gasoline had already been poured all over the barn by the financial sector via toxic derivatives.

    It looks like it might just happen again here…

    We’ll see.