According to the March 2022 Short-Term Energy Outlook (STEO) from the U.S. Energy Information Administration (EIA), the forecast is for high energy prices in 2022. The report found that Brent crude oil, used as a benchmark ex-U.S., is expected to see prices of $116 per barrel in Q2 of 2022. West Texas Intermediate (WTI), the price the U.S. uses as a benchmark, is expected to cost consumers, on average, $4.10 a gallon in Q2 of 2022.

The World Economic Forum blames volatile oil and energy prices in general on demand outstripping supply. This is attributed to OPEC not expressing a sense of urgency to ramp up supply, having a certain amount of spare capacity, and not being in a rush to create a glut in supply for global markets. Additionally, it’s attributed the lack of new exploration and resulting supplies coming online due to the shock of oil falling to -$40 per barrel during the COVID-19 pandemic. It also includes the transition to greener forms of energy, including pressure from activist investors looking to transition from fossil fuels. Hence, there are multiple factors putting pressure on traditional sources of fuel.

Looking further at the U.S. EIA’s March 2022 STEO, the price is expected to remain well above average. West Texas Intermediate (WTI) is projected to be $113 per barrel in March and average $112 per barrel in Q2 of 2022. The price per gallon domestically is projected to hit $4.12 in May of 2022, then drop through the rest of 2022. Over the entire year, the price per gallon of gas is projected to be $3.79 per gallon (the most expensive since 2014), and average lower to $3.33 per gallon in 2023.

It’s important to note that the EIA’s STEO was completed prior to the U.S. government’s March ban on importation of oil, liquified natural gas and coal from Russia, along with the United Kingdom announcing it was phasing out Russian oil imports by the end of 2022. The European Union also communicated that it would “significantly reduce fossil fuels” from Europe before 2030. These announcements were coupled with multi-national oil companies declaring plans to cease operations in Russia and end partnerships. These actions are expected to lower oil production by Russia, but the ultimate outcome is dependent on global reactions and how they impact fuel stocks.

When it comes to seeing how increased and likely sustained fuel prices will impact economies, history is a helpful guide to predict how things might play out in 2022. According to the Federal Reserve Bank of San Francisco (FRBSF), their data examines “the price of oil since the early 1950s.” According to the National Bureau of Economic Research, 1973 ushered in a period of volatility for oil, which contrasts with the FRBSF’s data on relatively stable prices through the 1950s.

In 1973, the Yom Kippur War disrupted prices and again the Iranian Revolution of 1979 saw another disruption. These energy market interruptions were both full of tepid expansion, hot inflation and too few jobs available for job seekers.  

Often considered a hidden tax on households, out of control inflation takes consumer interest away from other services and goods due to lowering a household’s affluence, along with giving consumers less economic certainty going forward. According to the Federal Reserve Bank of San Francisco, a 2007 study found that five of the past seven recessions occurred shortly after oil prices climbed substantially, attributed in part to lower levels of income and a less certain outlook for the economy.

As prices for gasoline increase, how much consumers will likely spend on other goods and services varies, according to a National Bureau of Economic Research paper titled “The Response of Consumer Spending to Changes in Gasoline Prices.” This research looked at the impact of gas falling during 2014. Based on U.S. Consumer Survey, the average total household spending was $53,495 in 2014, with $2,468 spent on gasoline per household in 2014. The same report points out that while crude was $100 per barrel in mid-2014, it went to sub-$50 per barrel by January 2015.

It’s important to keep in mind that while the price of oil was quite volatile, on par with that of the 1970s, inflation during the 1990s and 2000s didn’t really make material increases to inflation levels, impact GDP expansion negatively or lower the unemployment rate. The divergence and less deleterious effects of inflation during the 1990s and 2000s were likely set off by big gains in productivity realized in the first decade of the 21st century.

There’s nuance when determining if rising oil prices are helpful, hurtful or neutral for stock and market performances, according to a U.S. Energy Information Administration 2017 report called “Oil Prices and Stock Markets.” The study points out that looking at sectors or industries will give us a better picture of how oil prices impact stocks – whether it’s good, bad or neutral. For example, the study gives three ways to measure stock performance considering oil prices: “oil-users, oil-substitutes or non-oil-related.”

For example, all segments of the exploration, extraction, processing and refining of different energies (coal, natural gas, crude oil, etc.) will naturally see benefits. However, when it comes to manufacturers, transportation companies or food suppliers, these industries will see downward pressure on their earnings (and therefore stock price) due to pressure on increases of inputs and the mixed ability to pass on costs to consumers.

While the outlook for crude oil cannot be determined and geopolitical and economic conditions are fluid, it depends upon the sector and how businesses are managed when it comes to the probability of profitability of publicly traded stocks.

There’s much uncertainty surrounding if, how and when the Federal Reserve will raise its rates, end its bond and mortgage-backed security purchases, and wind down its balance sheet. For the March 16 Fed Meeting, the CME FedWatch Tool has a 47.9 percent probability of a 25 to 50 basis point increase, and a 52.1 percent probability of a 50 to 75 basis point increase for their Target Rate. There are many expectations for the Fed to raise its Federal Funds rate, or the so-called overnight lending interbank rate. However, there’s a lot of uncertainty as to how many times the FOMC will increase it.

John Williams, Federal Reserve Bank of New York president, mentioned at a recent event that the Federal Open Market Committee (FOMC) will start raising rates at its March 2022 meeting,  but he isn’t advocating for a particularly hawkish approach. Rather, Williams expects inflation to drop due to supply-chain bottlenecks being naturally worked out, along with the Fed’s measured policy actions moderating inflation. However, James Bullard, Federal Reserve Bank of St. Louis president, is more hawkish and has expressed a desire for a 50 basis point rate hike.

Lael Brainard, a member of the Federal Reserve’s Board of Governors, believes six rate hikes are an appropriate course for monetary policy, starting in March 2022. Charles Evans, Chicago Fed president, blames inflation on the pandemic and echoes that supply chain issues will resolve on their own as the world returns to its new normal. Evans also believes that hiring won’t be slowed with higher rates, compared to past rate hike cycles. However, this could change if inflation grows too high as 2022 progress, necessitating more rate hikes.

The Fed has communicated clearly that it will let 1) evolving economic data, in conjunction with 2) maximum employment, and 3) 2 percent longer-term inflation expectations, guide its monetary policy. Noting there’s been a strengthening labor market, it’ll continuously look at how the pandemic is managed healthwise, how global developments unfold and how inflation is expected to and materializes.

It’s important to note that during August 2020, the Fed took a new approach to inflation. Previously, the approach would be to increase borrowing rates during good economic times to prevent inflation from becoming a problem. However, as of August 2020, the Fed’s new approach is to maintain low rates until inflation actually materialized, permitting economic conditions that drive inflation above and below 2 percent. This would thereby create a longer-term average inflation rate of 2 percent when considering monetary policy adjustments.

This is within the perspective of inflation reaching 7.5 percent year-over-year in January 2022, according to the Labor Department. Month-over-month inflation readings include electricity rising 4.2 percent from December 2021 to January 2022. Food costs rose by 0.9 percent in January 2022, up from another 0.5 percent increase in December 2021.

According to the FOMC’s Jan. 26 meeting minutes, there’s much to be contemplated for any potential rate changes. The members found that inflation was elevated, with economic indicators showing inflationary pressures increased in the back half of 2021. In December, the 12-month change in the consumer price index (CPI) was 7 percent, while core CPI inflation was 5.5 percent over the same period.

The year-over-year November 2021 total personal consumption expenditures (PCE) price inflation was 5.7 percent, with the core PCE coming in at 4.7 percent for the same timeframe. When it comes to the unemployment rate, it fell from 4.2 percent in November 2021 to 3.9 percent in December.

Impact of Russia-Ukraine Conflict

Looking at the price of crude oil alone shows how inflation is fluctuating. On Feb. 24, futures contracts at one point had oil hitting $100 and $105 per barrel for West Texas Intermediate and Brent, respectively. While prices retreated, prices are still elevated and subject to international tensions, increasing demand due to the economy reopening from COVID and uncertainty over future output. Undoubtedly, the Fed will take inflation into account – both its new definition of longer-term 2 percent inflation and how it might impact the economy. Some speculate with the high volatility beginning in 2022, the Fed may raise rates by only 25 basis points, not the 50 basis points more hawkish FOMC members have mentioned.

With increased volatility since 2022 began and global uncertainty increasing by the day, it seems the FOMC will have the final say on how many rate hikes will eventually happen.