Latest / Energy Economics with Fexingo: Oil Prices, Renewables, and the Cost of Power / The Oil Shock That Is Reshaping US Inflation Expectations
Transcript
- Lucas: Look at the board today. West Texas Intermediate crude just broke through that psychological barrier of one hundred dollars a barrel, sitting at ninety-seven point three on the spot contract but futures are screaming higher at over one hundred two. Meanwhile, Brent is even more aggressive, pushing past one hundred nine dollars. Luna: That is a violent move in five days. A twelve percent jump feels less like a supply adjustment and more like a panic buy-in by traders who think something is about to break. Lucas: It is panic buying, but it is grounded in real structural constraints. We are seeing XLE, the energy select sector ETF, climb nearly one percent, but individual names like Exxon Mobil and Chevron are barely moving. The market isn't rewarding production; it's pricing in fear of disruption. And that fear is already leaking into your daily life, with regular gasoline holding at four dollars and sixteen cents per gallon despite the lag. Luna: Right, because the pump price is sticky. But here is the weird part: if oil is spiking this hard, why is the ten-year breakeven inflation rate completely flat at two point three seven percent? Lucas: That is the million-dollar question for investors watching the FOMC meetings. The bond market is telling us that consumers and businesses do not believe this oil spike will translate into persistent, broad-based inflation. They see it as a temporary shock to the head, not a new normal for the cost of living. Luna: Do you trust that calmness? Or is the bond market underestimating how fast energy costs can bleed into core services? Lucas: I am skeptical of the calmness, but I understand the logic. Let us look at the latest CPI data from early July. Core CPI, which strips out food and energy, was at three hundred thirty-six point eight. It ticked up slightly, but not explosively. The problem with an oil shock is that it takes months, not days, to work its way into the core metrics because so much of our consumption is shelter, healthcare, and services, none of which use crude oil directly. Luna: But transportation is everywhere. Logistics, trucking, shipping. If diesel prices follow crude, every single product on a shelf gets more expensive. Lucas: Exactly. And that is why the PCE price index is the Fed's favorite gauge. It came in at one hundred thirty-one point seven in July, up from one hundred thirty-one point four five. It is a slow burn. But we have to ask ourselves what happens when that slow burn hits a fuel source that just doubled in price over the last week. The transmission mechanism is there, it just has a delay. Luna: So the headline inflation number might stay quiet for a month or two, but the underlying pressure is building. Does that change the Fed's calculus on next week's rate decision? Lucas: It absolutely changes the risk profile. CNBC is already reporting that the likelihood of a rate hike next week has gotten significantly higher. When you combine a twelve percent weekly surge in oil with sticky core services inflation, the Fed is no longer fighting a deflationary ghost. They are fighting a cost-push reality. Luna: And they are doing it while the stock market is retreating. We saw equities pull back sharply as oil topped those levels. Investors hate uncertainty, and an oil shock creates a massive amount of it. Lucas: Uncertainty is the enemy of capital expenditure. When energy costs become volatile, companies freeze hiring and delay expansion. That is exactly what happened in the seventies, and it is what the Fed is trying to prevent from happening again. But here is the twist that nobody is talking about yet. Luna: Which is? Lucas: Natural gas. Henry Hub natural gas is actually falling, down four point six percent in five days to two dollars and eighty-four dollars per MMBtu. So we have a divergence. Oil is soaring, driving up transport and petrochemical costs, while power generation costs via natural gas are dropping. That gives utilities a little bit of breathing room, but it does nothing for the consumer at the gas pump. Luna: So the household budget is getting squeezed from the transport side, while the industrial side might be seeing some relief on electricity bills. That is a weird split. Lucas: It is a bifurcated economy. The people who drive get hammered. The factories that run on gas might actually see their marginal cost of power go down. But remember, most factories also use petroleum products for their own machinery and raw materials. So the relief is limited. Luna: Let me ask you about the political angle. With Trump's trillion dollar dividend plan facing bipartisan pushback right now, does this oil price spike make fiscal policy even harder to pass? Lucas: It makes it politically toxic. When gas prices are high, any government spending proposal looks like it is adding to the burden. The voters are feeling the pinch at the pump, and they are not going to vote for more deficit spending when their commute just got more expensive. The political window for expansionary fiscal policy has just snapped shut. Luna: So we are left with monetary policy as the only lever. And the Fed is walking a tightrope between stopping inflation and crushing growth. Lucas: Precisely. And if they hike rates too aggressively, they risk triggering a recession on top of the inflation. If they don't hike, they let the inflation expectations become unanchored. That is why the bond market is so calm right now. They are betting the Fed will make the wrong choice either way. Luna: Or they are betting that the oil spike is just too short-lived to matter in the long run. Maybe the demand destruction will kick in before the inflation sets in. Lucas: Demand destruction is a brutal word. It means people stop buying things because they cannot afford them. If oil stays at these levels for another quarter, we will see a noticeable dip in retail sales. People will cut back on discretionary spending to pay for gasoline. That contraction in demand will eventually force oil prices down, but it will leave a trail of bankruptcies behind it. Luna: That sounds like a classic stagflation setup. Stagnant growth, high inflation. Is that really where we are heading in September twenty twenty six? Lucas: We are not there yet, but we are standing on the edge. The key metric to watch is the trade balance. If the US imports more oil because domestic production cannot keep up with the price surge, we are exporting more dollars to pay for it. That weakens the currency, which makes all other imports more expensive, which fuels more inflation. It is a feedback loop. Luna: And we haven't even touched on the renewable energy sector. With oil this high, shouldn't green energy look more attractive economically? Lucas: Ideally, yes. But look at TAN, the solar ETF. It is down one point seven percent this week. Why? Because higher interest rates hurt capital-intensive projects. Solar farms require massive upfront investment. If the Fed raises rates to fight oil-driven inflation, the cost of financing those solar projects goes up. So the very tool used to kill inflation kills the alternative to fossil fuels. Luna: That is a cruel irony. The cure for the oil pain makes renewables less viable in the short term. Do you think that slows down the transition? Lucas: It slows the pace, but it doesn't stop the direction. The economics of solar and wind are still fundamentally better than burning dirt for energy. But the timeline gets compressed. Companies that were planning to transition in five years might now need to find efficiency gains in two years because their operating costs are spiking. Luna: So efficiency becomes the new growth engine. Not expansion, but squeezing more output out of existing assets. That is a very different kind of corporate strategy. Lucas: Exactly. Marginal efficiency. Every dollar saved on energy intensity becomes pure profit when input costs are volatile. We are going to see a massive wave of investment in heat recovery, logistics optimization, and material science that reduces oil dependency. Luna: It reminds me of the seventies again. Innovation under pressure. But this time, the technology is decades ahead of where it was then. Lucas: It is. We have batteries, ai driven grid management, and advanced manufacturing. The tools exist. The constraint is purely financial. If the Fed keeps rates high, the innovation happens, but it is slower and more painful. Luna: I want to pause here for a second. If walking through the economy with us has made something click, especially with these complex market moves, the way these stay ad-free is listener support. Buy me a coffee dot com slash fexingo. Lucas: Yeah, it really is the backbone of what we do here. We dig into the data so you don't have to guess at the headlines. If that saves you time or helps you see the bigger picture, consider keeping the lights on. Luna: Thanks for listening, and thanks for supporting independent economic analysis. Now, back to the data. Lucas: Let us go back to that divergence we mentioned. The gap between oil and natural gas prices. It is widening. And that tells us something specific about where the pain is concentrated. Luna: Concentrated in mobility. Transportation is almost entirely dependent on liquid fuels. You cannot run a semi-truck or a ship on natural gas easily yet. Lucas: Correct. So the inflation coming from this shock is asymmetric. It hits travel, tourism, and freight first. Services that involve movement will see their costs rise faster than stationary services. Hotels might raise prices because of flight costs, not because their building costs went up. Luna: So airfare and hotel rates could decouple from the general CPI trend. They might lead the inflation cycle upward. Lucas: They are leading indicators. Watch airfares closely in the next quarter. If they start climbing in lockstep with oil, then the Fed knows the shock has fully entered the consumer experience. And once the consumer feels it, they demand higher wages, which starts the wage-price spiral. Luna: That is the nightmare scenario. Wage demands driven by energy costs. It turns a temporary shock into a permanent structural shift in labor markets. Lucas: It does. And that is why the Fed is so nervous. They know that once wages start chasing energy prices, it is incredibly difficult to break that cycle without causing a deep recession. Luna: So we are waiting for the next CPI report to see if the seed has been planted. If core inflation jumps next month, the game changes. Lucas: If core inflation jumps, the Fed hikes. Period. There is no ambiguity left. They have to show they are serious about controlling the money supply, even if it hurts the stock market. Luna: And the stock market is already reacting. The retreat we saw today is just the beginning if the data confirms the inflation threat. Lucas: It is. Valuations are based on future earnings. If inflation eats into margins and rates eat into discount factors, both sides of the equation turn against equities. It is a double whammy. Luna: So the smart money is moving out of growth stocks and into value? Or maybe into commodities themselves? Lucas: Commodities are the obvious hedge, but they are volatile. Value stocks with pricing power are the safer bet. Companies that can raise prices without losing customers. Those are the ones that survive the shock. Luna: Pricing power is the ultimate moat. In an inflationary environment, the ability to pass costs on to the consumer is worth more than any technological advantage. Lucas: Absolutely. Technology can be copied. Pricing power is earned through brand loyalty and essentiality. That is what investors are looking for in this chaotic environment. Luna: It makes me wonder if we will see a consolidation wave in the service sector. Smaller players without pricing power will get squeezed out. Lucas: Highly likely. M&A activity usually picks up during these transitions as larger firms acquire distressed assets at a discount. We might see some interesting deals announced in the coming months. Luna: So the chaos creates opportunity for the acquirers. It is a brutal but efficient market mechanism. Lucas: It is. And ultimately, it resets the competitive landscape. The winners are the ones who adapt fastest to the new cost structure. Luna: Adaptation is the keyword. Whether it is a company changing its logistics or a consumer choosing cheaper travel options. The system is rebalancing. Lucas: It is. And we will see exactly how fast that rebalancing happens in the next few weeks. Keep an eye on the daily gas prices. They are the canary in the coal mine for the broader economy. Luna: Agreed. If gas prices stabilize or drop, we breathe easier. If they keep climbing, the Fed has its work cut out for it. Lucas: Right. One number at the pump tells us everything about the path of interest rates. It is a simple link, but a powerful one. Luna: Simple links often hide the most complex dynamics. We will be watching. Lucas: We will. And we will tell you what we find. Thanks for riding along with us through the energy shock today.