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Gas Prices Are High With No Near-Term Relief in Sight

Demand for oil is climbing, supply is tight and producers are not coming to the rescue.

By David Byrns, CFA, Mike Rode, CFA
Gas pump handles.

Key Takeaways

We expect prices to remain elevated as demand rises and some of the world’s largest oil exporters restrict output.

With profits rising, cost-conscious U.S. energy companies are unmotivated to expand production to close the supply gap.

We expect Russia-Ukraine war sentiment to affect near-term energy prices and electric vehicles and alternative energy sources to remain longer-term influences.

A More Expensive Commute

Those of us trying to settle back into our pre-COVID routines have received a rude welcome at the gas pump. The cost to fill the tank has more than doubled compared to pandemic lows, with the average price of a gallon of gasoline in the U.S. topping $4.32 in March 2022.1

What’s more, we don’t think there’s much near-term relief in sight. Crude oil prices are the biggest driver of what you pay for gas, and we believe the pieces are in place for prices to remain elevated.

High Gas Prices Provide an Unwanted Lesson in Economics

What we’re paying at the pump provides a clear example of how supply and demand work together to determine prices.

We view the crude oil supply as the dominant factor in today’s environment. When oversupply caused crude prices to fall into negative territory during the pandemic-induced recession of 2020 (Figure 1), a group of the world’s top oil-producing nations agreed on output limits to help stabilize prices. The agreement has expired, but producers continue to restrict output despite growing consumption.

In the meantime, oil demand rebounded as wide vaccine availability helped accelerate the economic reopening. We’re nearly back to pre-COVID consumption levels with the high-demand summer vacation season still ahead of us. We expect this combination of tight supply and rising demand to keep upward pressure on prices.

Figure 1 | Oil Prices on a Rollercoaster Due to Pandemic-Era Swings in Demand and Supply

$/Barrel (West Texas Intermediate Crude Oil)

Line chart showing stable oil prices from 2015 until the dramatic fall and rise in prices from early 2020 through March 31, 2022.

Data from 12/31/2014 – 3/31/2022. Source: FactSet.

War Tightens the Lid on Supply

The runup in oil began even before Russia invaded Ukraine. Commodity traders bid up the price due to expectations that the war and potential sanctions against Russia would disrupt the already constrained market.

Russia accounts for 11% of global petroleum output.2 Wary of turning off the spigot on such a large source, the U.S. and its allies have refrained from directly sanctioning Russia’s energy sector. Instead, they’ve focused on industries that affect the country’s ability to get its oil to market.

For example, ships that transport Russian crude are having difficulty procuring marine insurance, and they can’t sail without it. The International Energy Association estimates indirect impediments such as this one will curtail the delivery of the country’s oil by up to one-third.

Can the U.S. Pump More Oil to Meet Demand?

The U.S. is already the world’s largest oil supplier.3 However, U.S. producers appear unable to significantly increase current production from levels as they deal with the same labor and supply chain problems plaguing other industries.

Even without these challenges, U.S. energy executives aren’t eager to increase capacity. Industry profits suffered from 2010 to 2019 because companies spent too much on drilling and did not generate enough cash flow to satisfy shareholders. As a result, influential investors are now forcefully lobbying management teams against ramping up production and repeating the sins of the past.

The energy sector’s remarkable performance in early 2022 helps explain the reluctance to expand capacity. Thanks to more disciplined cost management and sharply higher oil prices, energy company profits are climbing. Accordingly, energy stocks shot up nearly 40%, while the broader U.S. market declined more than -4.5% during the three months ended March 31, 2022.4 See Figure 2.

Figure 2 | The Energy Sector Was a Rare Bright Spot During the Dismal First Quarter of 2022

Q1 2022 S&P 500 Sector Returns (%)

Bar chart showing the Energy sector’s total return of nearly 40% compared to negative returns for most other sectors during the three months ended March 31, 2022.

Data from 12/31/2021 – 3/31/2022. Source: FactSet, American Century Investments.

OPEC Not Likely to Come to the Rescue

The Organization of Petroleum Exporting Countries (OPEC) also is unlikely to step up production. Comprised of some of the world’s top producers, OPEC members are experiencing a windfall from high prices and have no incentive to back off their 2020 production caps.

Global politics further complicate the situation. The U.S. is trying to negotiate a nuclear deal that would remove economic sanctions against Iran. These discussions are not sitting well with Saudi Arabia, Iran’s long-time regional rival and the most influential OPEC member.

While abandoning the Iran deal and keeping sanctions in place could open the door to OPEC pumping more oil, we think this outcome is uncertain and unlikely to occur quickly, if at all.

Where Will Gas Prices Go From Here?

With domestic and international oil producers raking in profits and unmotivated to increase supply, it’s hard to be optimistic about the prospects for lower gasoline prices anytime soon.

We believe sentiment about the Russia-Ukraine war will loom large in the near term. If the West directly sanctions Russia’s energy industry or President Vladimir Putin interrupts exports as a political tactic, we think it’s possible oil prices could surpass March’s $130 spike. On the other hand, we expect prices to pull back if there’s a peace deal or the war de-escalates.

Longer term, we think environmental, social and governance (ESG) considerations, electric vehicles and alternative energy sources could be a factor that affects demand. From 2015 through 2019, oil averaged roughly $53 per barrel. Looking at the next five years, we expect the cost to remain high relative to the last five years but believe sustained long-term prices over $100 per barrel are unlikely.

High Energy Prices Tax the Economy and Cloud Our Outlook

None of this is making consumers or investors happy. In addition to claiming a more substantial chunk of our paychecks or retirement income, high energy prices act as a tax on the economy. The impacts ripple into the cost of goods and services, which businesses pass along to us.

Consequently, beyond the price of gasoline itself, the soaring cost of energy is a significant factor pushing inflation to its highest levels in 40 years.

Rising prices often cause us to overlook the positives. For perspective, the U.S. economy is sound, unemployment is low, corporate profits are healthy and interest rates are still low by historical standards. Even so, the University of Michigan’s widely followed gauge of consumer sentiment has been declining steadily since mid-2021.5

We think weakening sentiment along with high energy prices, inflation, rising interest rates and geopolitical uncertainty set the stage for continued volatility in the months ahead.

David Byrns, CFA
David Byrns, CFA

Portfolio Manager

Senior Investment Analyst

Mike Rode, CFA
Mike Rode, CFA

Vice President

Investment Director

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U.S. Energy Information Administration. Reflects average monthly price of all grades in the U.S. as of 4/4/2022.

U.S. Energy Information Administration.

U.S. Energy Information Administration.

FactSet. Broad market performance is based on the Standard & Poor’s 500 Index. Energy sector performance is based on the index’s energy sector constituents.

Trading, data as of 3/25/2022.

The opinions expressed are those of American Century Investments (or the portfolio manager) and are no guarantee of the future performance of any American Century Investments' portfolio. This material has been prepared for educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal or tax advice.