Oil prices suffered a 16 per cent retreat over the past month as the sharp fall in the euro reduced the appeal of oil as an alternative investment. But despite the fall, oil and gasoline prices have been generally on a rising trend in recent times.
When oil prices hit over 85 dollars a barrel in mid-April, some observers feared it may derail the recovery and plunge the U.S. back into recession. Jeff Rubin, a former CIBC chief economist and author of a book on oil and globalization, told the Financial Times newspaper: "Triple-digit oil prices are going to threaten a world recovery."
How so? Firstly, higher oil prices mean higher gasoline prices. Although many other factors, such as currency fluctuations, taxes, and government regulations influence gasoline prices, the single biggest determinant is the global price of crude oil. The U.S. Department of Energy estimates show that nearly 80 per cent of the cost of a gallon of gasoline covers the the price of crude oil along with taxes. The remaining 20-odd per cent covers the cost of refining, distribution and marketing.
High gasoline prices have a detrimental effect on a country's national output as they hurt the consumer's spending power. But instead of cutting back on gasoline buying, consumers usually respond to drastic price changes by compensating in other areas of retail spending.
This is because gasoline prices have what economists refer to as an "inelastic" quality - i.e., when prices fluctuate, demand more or less remains the same. Prices of general consumption products usually have a higher level of elasticity attached them. For example, a one per cent increase in the price of a product, such as a beverage, will result in a say, two or three per cent decrease in consumption as consumers have the option to spend on a different brand of beverage.
But in gasoline's case the elasticity tends to be low because there are few directly available substitutes that consumers can turn to. And because it is difficult to reduce spending on gasoline, the effects of higher gasoline prices are felt in other economic sectors.
Sharp rises in the price of oil have a direct impact on dampening consumer sentiment by forcing consumers to postpone purchases of consumer durables and put off vehicle purchases. Because the affected sectors cannot shift through a period of depressed demand without sustaining losses, they are forced to cut back and restructure. The result is unemployment in the affected sectors, which brings down the economy.
Changes in oil prices also have an enormous impact on businesses, directly affecting the price of most goods and services, particularly transportation, building materials, tourism and food. The airline industry was among the worst-hit in the summer of 2008, when oil prices hit a record-high 147 dollars a barrel.
But could global oil prices approach those highs again in the medium term? The International Monetary Fund doesn't think so. It estimates oil prices to average around 80 dollars a barrel this year and 83 dollars next year, which is not too far from current price levels. "Options prices for oil suggest that downside risks to growth from high prices have also diminished," the IMF said in its latest outlook report.
U.S. gasoline prices are forecast to average around 2.94 dollars per gallon during this summer's driving season (April 1 to September 30) by the Energy Information Administration. While that is 50 cents higher than gasoline prices during the summer of 2009, it is still a dollar lower than the highs recorded in 2008.
In summary, it appears that the gradual movement of oil prices in recent times is unlikely to threaten the U.S. recovery and spark a double-dip recession. Gradual price changes give consumers time to adapt and alter their behavior in such a way that the wider economic recovery is not endangered. Geopolitical shocks spurring price rises cannot be ruled out.
Although it has not had a significant impact yet, the fallout from the April 20 explosion aboard the Deepwater Horizon drilling rig and the subsequent oil spill in the Gulf of Mexico could yet hold some nasty shocks for the energy sector. The U.S. government has already halted issuance of drilling permits and has imposed a six-month moRatorium on deepwater drilling - a move which some observers say could boost oil prices in the long-term.
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May 01, 2026 15:54 ET Central banks dominated the economics news flow this week with almost all major ones announcing their latest policy decisions and many boosted expectations for a rate hike in June. In other news, several countries released the preliminary data for first quarter economic growth. In the U.S., comments by Fed Chair Jerome Powell were also in focus as his term ends this month.