$130-A-Barrel Oil Could Send Economy Into a Recession

Key Takeaways

• The U.S. economy could fall into a recession if the price of oil reaches $130 a barrel and stays there, economists at Wells Fargo Securities said Tuesday.
• The price of oil has whipsawed up and down in recent days as the Iran war has restricted tanker traffic through the crucial Strait of Hormuz.
• High oil prices would push up gasoline and diesel prices, tanking consumer confidence and reducing spending, leading to job losses, the economists said.

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If you’re watching the price of oil on its recent roller coaster ride, there’s a key number to keep in mind: $130 a barrel, the level at which oil is expensive enough to push the U.S. economy into a recession.

That’s according to economists at Wells Fargo Securities, who found that if crude oil reached that price level and stayed there, it would push gas prices up high enough to force households to cut back on spending and businesses to start laying people off.

“An oil price shock becomes recessionary when it turns a slowing expansion into a self-reinforcing downshift: real income falls, consumption growth slows, investment contracts, hiring weakens, and income declines further,” economists led by chief economist Tom Porcelli wrote in a commentary Monday.

The price of oil has whipsawed up and down since Feb. 28, when the U.S. and Israel began bombing Iran, prompting the virtual closure of the Strait of Hormuz, the vital waterway through which 20% of the world’s oil supply flows.

The price of a barrel of Brent Crude, an international benchmark for oil prices, briefly shot up to $117 on Monday, a 67% increase from its prewar price. Gasoline prices followed suit, surging to a national average of $3.56 for a regular gallon on Tuesday, up from $2.98 before the war, according to data from Gasbuddy.

“Although the Strait of Hormuz is not physically blocked, the threat of attack by Iran and the cancellation of insurance coverage have led most tankers to avoid transiting the Strait,” the Energy Information Administration said Tuesday. “As a result, some oil production in the region has been shut in. If this reduction in vessel volume persists, oil storage behind the chokepoint will quickly fill, causing oil producers to shut in even more production, lending further support to oil prices.”

What This Means For The Economy

The recession threshold is a key benchmark to keep in mind when monitoring the price of oil and assessing its impact on the economy.

Fortunately for the outlook for the U.S. economy, since then, prices have fallen to roughly $85 Tuesday afternoon after President Donald Trump sent mixed messages about how soon the war would end, raising hopes in financial markets that the strait would reopen soon and gas prices would cool down in the coming days.

Still, the energy crunch is hitting the U.S. economy at a time when inflation has run stubbornly high and the job market was already starting to look vulnerable, with employers shedding 92,000 jobs in February.

A sustained oil price surge would be dangerous not only because it would sap household spending, but also because of its psychological impact on consumers, Wells Fargo economists said.

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“Higher inflation expectations, weaker sentiment, and tighter financial conditions that make investment harder and ding household consumption, particularly for the higher income cohorts currently driving spending growth,” they wrote. “Market concerns about growth have the potential to become self-fulfilling by choking off the confidence/wealth channel and turn what has already felt like a recessionary environment for many Americans into an actual recession.”

Forecasters currently expect oil and gas prices to subside in the coming months, but that assumes the war ends soon and the strait reopens. Brent Crude will stay over $95 for two months before falling to its prewar price by the end of the year, the EIA forecast. Gas will average $3.58 a gallon in March before falling back to around $3 by the end of the year, the EIA said.

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