Latest / Energy Economics with Fexingo: Oil Prices, Renewables, and the Cost of Power / Why a 5% Oil Drop Doesn't Mean Lower Gas Prices Yet
Transcript
- Lucas: West Texas Intermediate crude fell below 85 dollars a barrel this morning, down about 5 percent over the last five days, after Iran reportedly signaled it would halt attacks if the U.S. holds its pause. That's the biggest geopolitical risk premium unwind we've seen in weeks. Luna: But regular gasoline is still sitting at 4 bucks a gallon, according to the latest EIA data. So why aren't we seeing any relief at the pump? Lucas: Great question. That's exactly the disconnect. The crude drop is real — Brent is also down about 2.3 percent over the same stretch. But gasoline prices don't move in lockstep because of refining margins. The spread between crude and what refineries can sell gasoline for — the crack spread — has actually widened. Luna: So refineries are capturing the margin? That feels like a supply chain issue more than a demand story. Lucas: Exactly. And it's seasonal, too. We're in the middle of summer driving season, and a lot of refineries are running near capacity. But the bigger structural factor is that U.S. refining capacity is still below pre-pandemic levels — we lost about a million barrels a day of capacity during COVID and haven't fully recovered. Luna: And then on top of that, you've got the Iran news potentially taking a supply risk off the table. But if refineries can't process more crude, a lower oil price doesn't automatically mean cheaper gas. Lucas: Right. That's the refined product bottleneck. Now, the other interesting piece is what the macro data says about demand. The June CPI came in at 332.6, down from 333.98 in May — so headline inflation is cooling. Core CPI was essentially flat. And the 10-year breakeven inflation rate ticked down to 2.26 percent. Luna: Breakevens falling suggests the bond market is pricing in lower inflation expectations, even as oil and gasoline are elevated. That seems contradictory. Lucas: It does, until you realize that the market is looking past the current commodity spike. The breakeven rate reflects expectations over the next ten years, not just this month. And if the Iran ceasefire holds and global demand softens — especially with China's economy still sluggish — then oil prices could stay subdued. The bond market is betting that the energy price shock is transitory. Luna: That's a big bet. We've seen transitory narratives before. But the Fed has been watching inflation expectations closely. If breakevens keep falling, it might give them cover to ease off on rate hikes sooner. Lucas: If this episode helps make sense of what's happening with energy prices and inflation, that's great. These ad-free daily shows only exist because of listener support. If you find value in walking through the economy with us, you can toss a few dollars into the digital coffee jar at buy me a coffee dot com slash fexingo. It genuinely keeps us going. Luna: Yeah, agreed. It's a small way to say this kind of deep-dive economics matters. So thanks to anyone who does. Lucas: Alright, back to the refining picture. The key question for the next few weeks is whether the Iran ceasefire actually holds. If it does, the risk premium could further erode, pushing WTI into the high 70s or low 80s. But gasoline might not follow until after Labor Day when demand seasonally drops. Luna: And on the inflation side, the core PCE index for May came in at 130.1, up from 129.67. So the Fed's preferred measure is still creeping higher, even if breakevens are down. That complicates the picture. Lucas: It does. Core PCE is sticky because it excludes food and energy, so the oil drop doesn't directly affect it. But if lower oil feeds into cheaper transportation and industrial inputs, that eventually shows up in core goods inflation. It just takes time. Luna: So we've got two competing forces: falling oil from geopolitics, and sticky core inflation from services. The energy sector stocks — like Exxon and Chevron — are basically flat this week. XLE is barely moving. That suggests the market sees the oil drop as a temporary shock, not a structural change. Lucas: Exactly. And the broader market seems to agree. The S&P 500 is shrugging off oil's decline because lower energy costs are actually a net positive for most sectors. It's that old adage: oil is a cost for the economy, not a benefit. So the stock market might actually prefer crude to stay below 85. Luna: Unless you're an oil producer. Then you want prices higher. But the Iran headline is a good reminder that geopolitics can shift the supply outlook overnight. The question is whether the market has fully priced in a durable de-escalation. Lucas: And I think the answer is no. Because the contango in the futures curve has actually steepened a bit — meaning near-term prices are falling faster than long-term ones. That's a signal that traders still see some tail risk from the Middle East. The risk premium isn't gone; it's just smaller. Luna: So the bottom line: a 5% oil drop doesn't mean $4 gas is going away soon, thanks to refining bottlenecks. And for the Fed, lower breakevens are welcome, but core PCE still has to cooperate. Lucas: Exactly. We'll be watching the weekly EIA inventory report on Wednesday. If we see a big crude build, that could confirm the risk premium is truly unwinding. But if gasoline inventories keep drawing down, expect pump prices to stay stubborn. Luna: And maybe a side order of volatility from any new Iran headlines. It's never dull in energy economics. Lucas: Never. Alright, that's our show for today. Thanks for listening.