Latest / Energy Economics with Fexingo: Oil Prices, Renewables, and the Cost of Power / Why WTI Dropped Below 70 on Iran Strikes But Gas Prices Stayed Sticky
Transcript
- Lucas: So WTI crude briefly dipped below 70 dollars a barrel on Friday after the US military struck Iranian targets in response to that commercial tanker hit in the Strait of Hormuz. But here's the thing — regular gasoline at the pump only fell from four-oh-five to three ninety-one a gallon over the same period. That's about a three and a half percent drop, compared to crude falling more than five percent. Luna: Right, and that gap is exactly what caught my eye. The market is basically saying the crude price shock isn't passing through to consumers the way you'd expect. Lucas: Exactly. And it's not just this week — we've seen this pattern for months. Episode 62 was all about why the oil-gasoline gap stays sticky, but now we have fresh data points. The latest CPI reading from May came in at 334, up from 332.4 in April. Core CPI, which strips out food and energy, hit 336.1. So inflation is still running hot, and gasoline is a huge component of that headline number. Luna: And the PCE price index, which the Fed watches more closely, also ticked up — 131.5 in May from 130.9 in April. Core PCE went from 129.7 to 130.1. So even if crude drops, the broader price level is still drifting higher. Lucas: Right. The key question is: why does a five percent drop in crude only translate to a three percent drop at the pump? Let's walk through the mechanics. First, crude oil isn't gasoline. It has to be refined, and right now US refinery utilization is running above 93 percent. That's high. When refineries are near capacity, they have pricing power. They don't have to pass along the full crude drop. Luna: So the bottleneck is refining, not crude supply. That makes sense. And it's not just capacity — it's also the type of crude. The US produces a lot of light sweet crude, but many refineries are configured for heavier grades. So even if WTI drops, some refineries can't easily switch. Lucas: Exactly. The brent wti spread also widened this week — Brent closed at 72.60, down almost six percent over five days, but still at a premium to WTI's 69.23. That tells you the global market is still tight, especially with the Hormuz disruption threatening tanker routes. About 20 percent of the world's oil passes through that strait. Luna: And that's probably why natural gas rallied four point two percent this week to three twenty-eight per MMBtu. If oil supply gets disrupted, power generators and industrial users start looking for substitutes. Natural gas is the most obvious one. Lucas: Yeah, Henry Hub futures jumped to three twenty-eight, which is a multi-month high. The narrative is shifting from 'oil glut' to 'supply risk,' and gas is benefiting. But here's the irony — the same CPI data that shows sticky inflation also shows that energy prices are still a big part of the story. The ten-year breakeven inflation rate actually dipped slightly to 2.20, down from 2.21. That suggests the bond market thinks inflation expectations are well-anchored, at least for now. Luna: But the Fed cares about actual inflation, not just expectations. And with core PCE still above 2.6 percent year over year, they're not going to cut rates anytime soon. That's a headwind for oil demand too — higher rates slow the economy. Lucas: Right, and you can see that tension in the oil futures curve. WTI for August delivery is around 69, but the six-month forward is closer to 66. That's backwardation flipping to contango — a signal that the market expects near-term supply fears to fade and demand to soften. Luna: So the military strike is a supply shock, but the economic data is a demand drag. Those two forces are pulling in opposite directions, which explains why crude isn't spiking the way it might have in earlier decades. Lucas: Exactly. If this were 2008, a strike on Iran would have sent oil to 150. Now, the market has more tools — strategic reserves, more diverse supply from US shale, and a slower global economy. The IEA estimates global oil demand growth this year at just 0.8 million barrels per day, down from 1.6 million last year. Luna: And yet, gasoline is still almost four dollars a gallon. That's the part that frustrates consumers. They see headlines about oil dropping below 70, but their fill-up costs the same. Lucas: Well, let's break down the three-ninety-one number. According to the EIA, about 54 percent of the retail price is crude, 14 percent is refining, 16 percent is distribution and marketing, and 16 percent is taxes. So if crude drops five percent, the pump price should theoretically drop about two point seven percent. That's almost exactly what we saw — three point five percent. So the pass-through is actually close to textbook. Luna: So the perceived stickiness is partly just math. But there's also a behavioral element — stations don't lower prices as fast as they raise them. That's the 'rockets and feathers' phenomenon. Lucas: Right. Prices go up like a rocket and down like a feather. That's well-documented in the economics literature. A 2023 study by the Federal Reserve Bank of Atlanta found that retail gasoline prices adjust twice as fast to crude increases as to crude decreases. So even if the mechanics are clean, the timing is asymmetrical. Luna: And that's probably why the CPI is still sticky. The May CPI reading of 334 reflects prices that were set when crude was higher. The June data, which comes out in mid-July, will start to show the recent drop. Lucas: Good point. There's always a lag. The PCE data we cited is for May, so it doesn't capture this week's oil move either. But the bond market's breakeven rate dropping to 2.20 suggests that investors expect inflation to moderate, partly because they think oil will stay weak. Luna: But if oil stays weak, that's good for the economy, right? Lower energy costs mean more disposable income for consumers. Lucas: In theory, yes. But we did an episode — Episode 72 — about why falling oil prices aren't always good news. When oil drops because of a demand shock, it's a symptom of a slowing economy. This week's drop is partly supply-driven — the strike and the Hormuz risk — but it's also demand-driven, with factory job cuts and weak Chinese data weighing on sentiment. Luna: So the net effect on the economy is ambiguous. Cheaper gas helps consumers, but it also signals weaker global growth. The Fed is watching both. Lucas: Exactly. And that brings us back to natural gas. The rally in gas is interesting because it's not just a supply-disruption hedge. It's also a reflection of relative value. With oil at 69 and gas at three twenty-eight, the oil to gas price ratio is about 21 to one. Historically, that's around the long-term average. But if oil stays weak and gas keeps rallying, that ratio could compress. Luna: And we're seeing that in the energy equity space too. The XLE energy ETF is basically flat on the week, while the XOP oil and gas exploration ETF is up slightly. So the market is rewarding gas exposure. Lucas: Right. ExxonMobil and Chevron are both down slightly this week — Exxon at 136.54, Chevron at 171.06. But ConocoPhillips, which has more gas exposure, is holding up better at 105.96. That's a clear signal. Luna: Let's talk about the clean energy side. Enphase is down nine percent this week to 47.58. That's brutal. And the ICLN global clean energy ETF is at 19.50. So the sell-off in clean energy is continuing, even as oil drops. Lucas: Yeah, we covered that in several episodes — 74, 75, 76. The pattern is that clean energy stocks are falling faster than oil stocks, partly because they're more sensitive to interest rates. Higher rates hurt the net present value of future cash flows for solar and wind projects. And with the Fed holding rates high, that's a headwind. Luna: But lower oil prices should theoretically make renewables more competitive on a relative cost basis. So why aren't they rallying? Lucas: Because the market is focused on the interest rate channel, not the substitution channel. Also, many clean energy companies have high debt loads that become more expensive to service when rates are high. The TAN solar ETF is at 56.85, down significantly from its 2024 highs. First Solar is actually up slightly this week at 239.07, but that's an outlier. Luna: So the takeaway is: oil drops, gas rises, clean energy falls. It's a tale of three energy markets, each driven by different factors. Lucas: Exactly. And the connecting thread is the macro environment — a geopolitical supply shock hitting a demand-constrained economy, with the Fed watching inflation data for signs of progress. The next CPI print, due July 15, will be a big test. Luna: Speaking of the show, if walking through the economy with us has made something click — like understanding why gas prices don't move one for one with oil — it's worth noting that these episodes stay ad-free because of listener support. A couple of dollars a month is genuinely what keeps them going. Lucas: Yeah, it's true. We don't run ads, we don't have sponsors. It's just us and the data. If you've gotten value from the show, you can toss a few bucks at buy me a coffee dot com slash fexingo. That's all lower case, no spaces. It makes a real difference. Luna: And it means we can keep doing deep dives like this one without any outside pressure. So, back to the oil-gasoline gap — what are you watching for this week? Lucas: I'm watching the EIA inventory data on Wednesday. If we see a big draw in crude stocks, that could signal that the Hormuz disruption is having a real impact. But if inventories build, it means demand is weakening faster than supply, and we could see WTI test 65. Luna: And on the gas side, the Henry Hub forward curve is in backwardation for the next few months, which suggests the market expects prices to stay elevated through summer. That's good for producers, but it adds to inflation concerns. Lucas: Right. So the energy inflation story isn't over. It's just shifting from oil to gas. And the Fed is going to have to navigate that carefully. Thanks for listening, everyone — we'll be back with more on Wednesday.