The US inflation rate is on the rise—and it doesn’t look like it will slow down any time soon. In June, the U.S. Federal Reserve’s primary measure for inflation, the core price index for personal consumption measures, had increased 3.1% over the prior year, which is well above the 2% long-term target that the central bank seeks.
How will that affect oil and gas prices, and what does this mean for investors in oil and gas? Here at Eckard Enterprises, we like to stay in the know—and that’s why we’ll explore those answers and more below.
- Historically, oil and gas prices were a driver of inflation, but in the modern economy, there is little correlation between rising oil prices and rising inflation rates.
- Investments in commodities could prove profitable in the short term, but the market bears watching.
- Oil and gas prices will stabilize at some point—but it’s hard to tell whether this will happen naturally, or whether OPEC will use surplus oil to stabilize the market.
How Are Oil and Gas Prices Related to Inflation?
The relationship between oil and gas prices and inflation is a complex one. Historically, oil and gas prices had a major effect on the CPI (consumer price index). Back in the 1970s, during two different oil crises, inflation rose along with rapidly rising oil prices.
In the modern economy, the relationship between oil and gas prices and inflation is less clear. Even when oil prices are high, the CPI remains generally stable—which translates to little or no inflation on consumer goods. The inflationary link is stronger between oil and the PPI (producer price index). In other words, wholesale goods suffer from inflation as gas and oil prices go up. This is likely because wholesale goods rely more heavily on oil production inputs whereas the CPI doesn’t rely so strongly on oil and gas.
What Does The Inflation Impact Mean for Oil and Gas Investors?
Typically when inflation is high, investors do well to invest in commodities. Oil is a big one since society cannot function without it—and oil prices are on the rise right now. This makes direct investments in oil futures or oil options a profitable investment, though oil futures are volatile and most often used as a short-term investment vehicle.
However, there is also a degree of uncertainty in commodity markets. Will oil and gas prices come back down? The commodities market is known to ebb and flow along cyclical patterns—and prices could drop should governments or OPEC step in to regulate oil prices or to channel surplus oil into the markets.
What to Expect
As things progress, oil prices will stabilize at some point—and possibly even drop. With other commodities, like timber or ore, prices keep rising when supply is low and demand is high because there is a physical bottleneck in goods. Producers must produce more to exceed market demand and bring prices back down.
The oil and gas industry works a bit differently. OPEC producers have a stockpile of roughly 7 million barrels per day of unused oil, so the future of prices in these markets depends largely not only on oil producers scaling up production but also on what OPEC producers eventually end up doing with this spare capacity.
In the near term, prices on oil and gas will likely continue to rise. However, if higher prices prove unsustainable in the longer term, then OPEC producers may need to use their spare capacity to stabilize oil prices or bring them back down.
What this Means for Your Money
For the shrewd investor, rising oil prices mean that now could be a good time to invest in stocks and bonds in the oil and gas industry as well as direct mineral ownership. When you own direct mineral rights, you benefit from higher mineral prices.
Though COVID-19 has caused inflation as evidenced by a rising CPI, oil and gas prices are not directly tied to inflation, which makes them an attractive option. For more information, visit our resource center to learn more about the energy sector.