Yesterday I pulled into my local gas station and went through the automated motions of filling up my non-green, oil consuming, emission generating vehicle while thinking about my day of meetings ahead of me. While the pump did its job I checked my email and scrolled the web for the latest headlines out of Europe. As the pump shut off I extracted the nozzle from my car and replaced it on the pump while looking up to see what the damage was going to be to my credit card. What? I had to look twice as the pump read $39.02. I am normally pushing over $50 during my regular fill-ups so breaking $40 was delightful. I then looked down to see what the cost of the unleaded fuel was per gallon - $3.08. My only thought at that elated moment was "cool".
As I got back into my car I decided to do two things: 1) take myself out to a more expensive lunch today with my new found savings; and 2) I quickly scrolled my phone to find the price of oil. At $101 a barrel going into the market open our commodity longs were doing great - but it got me to thinking about how the price of gasoline could be so cheap at the same time the price of oil was cresting the century mark? The implications from a rise in gasoline prices in an already weak economy would have negative ramifications not only on the consumer but the markets as well. Considering the consumer went into the retail shopping season cash poor, as shown by the rampant usage of credit cards on "Black Friday" which outstripped cash and debit-card payments by more than a two-to-one, the recent sharp drawdown in the personal savings rate and the declines in incomes; any rise of gasoline prices would quickly deplete the already thin consumer wallet.
When I got to the office my first thought was to look at the correlation between oil and gasoline prices. Historically, gasoline tends to lag movements in the price of oil. If we look at just the nominal price data going back to 1990 we can see that there is indeed a very high correlation between oil prices and gasoline prices. While divergences from each other do occur on occasion those divergences tend not to last for very long with gasoline usually correcting towards the price of oil. (This really should not be a shocker considering gasoline is a byproduct of oil but stay with me here ...)
What was surprising with the most recent data was the sheer magnitude of the divergence between oil and gas prices. The current gap is very similar to the gap that was witnessed just prior to the recession starting in 2008. Gasoline prices declined temporarily even as oil prices were still rising - however, the divergence quickly melted up until the back of the consumer was broken. What is also important to note for commodity bulls, like us, is that recessions have a very negative impact on commodity prices and swings can be very large. Therefore, it is prudent to hedge long commodity exposure going into a potential recessionary environment.
(Click to enlarge)
We can see this current divergence a little differently if we look at the rolling 4-month average (smoothing) change in oil prices versus gasoline prices. While oil prices maintain a much higher volatility level there is a very high correlation between the movements of oil prices as they relate to gasoline prices. The recent surge in oil prices leaves the price of gasoline diverged from its normal correlation. If oil prices remain where they are for much longer the price of gasoline should start to rise and sharply. Again, it is very questionable whether the consumer, and ultimately the economy, can withstand much higher fuel costs at the current time.
We have written recently that our prediction of a recession in 2012 is still very much on the table given the underlying economic environment. Outside of the mainstream headlines of upticks in economic data the underlying trends remain exceptionally weak. If we look at the spread between oil and gasoline prices we are currently approaching levels that triggered the last recession. Of course, the question that needs to be asked is whether oil prices will remain at these levels, or potentially higher, in the near term.
There are several points that support that case for stable to higher oil prices:
- If another Quantitative Easing program is implemented in either Europe, the U.S or both - the flood of liquidity will roll into the commodity markets.
- Not getting a lot of headline attention currently due to the impending crisis in Europe is the threat of Iran. If there is any escalation in Iran in the coming weeks it will well provide a catalyst.
- If a year end "Santa Claus" rally continues money flows will chase performance.
- Any decline in the dollar due to some positive news out of Europe.
Of course, this doesn't even mention all the trips to "Grandma's house" that are about to launched by drivers all across the country to deliver Christmas cheer. Retail gasoline providers will surely be moving prices higher to capture additional driving miles for the season and ringing in of the new year.
The conclusion here is that with food and energy prices already consuming more than 23% of a wage and salary base, which have declined over the last 2 quarters - lower gasoline prices, which act as a tax rebate in this case, have given consumers more flexibility to make ends meet. With the GOP and the Democrats locked up over an agreement on how to pay for further extensions of last year's tax cuts - this could lead to higher payroll taxes come the first of the year. That additional drag on incomes combined with any rise in a "gasoline price" tax are going to hit the consumer, and the economy, where it hurts the most.