In anticipation of and following major geopolitical tensions between Israel, Iran, and the United States, the cost of a barrel of crude oil in May 2025 has risen from a low of approximately $60 to $77 (it will, no doubt, be lower or higher when you read this; there is currently a lot of price volatility). That is a per-barrel increase of $17. I am loath to write about the economy in the context of war because it is insignificant compared to the tragedy and horror felt by so many people. Nonetheless, I have a job to do.
Earlier today, I was at the gym. Afterward, I went to the grocery store, then stopped to get an iced coffee, preparing myself for the stream of consciousness that would leave my body and exit my fingertips onto this click-clacking keyboard. At none of those places did anyone seemingly do anything other than focus on what they had to do for themselves and their families. I will draw my lead from them and do the same, focusing on my job by calculating what higher oil prices may mean for the U.S. economy.
A sustained increase of $10 per barrel of oil equals 25 cents per gallon at the pump. Consumers spend about $2,400 per year on gasoline, so they will feel the impact.
Consumers spend money not just on gasoline but on other types of energy goods and energy services, such as heat, cooling, and electricity. Some energy is derived from natural gas and some from crude oil. Then there are indirect channels, such as diesel for transporting goods we buy or jet fuel for the trips we take, both of which affect our final costs.
If you add all that up, you have a $40-$50 billion hit to households, or about $375 per year for the typical household, for every $10 increase in the price of a barrel of oil. That is money households will not have to spend on other things, which will result in a tax increase. That is a lot of money for you and me, and like I said, we have already seen a $17 increase. That figure could decrease or continue increasing depending on our geopolitical status.
That $40-50 billion hit is only about 0.15 percent, or 15 basis points, of the U.S. Gross Domestic Product (GDP). It is meaningful, but not an economy-killer. Let’s also keep in mind that we are just talking about what happens over roughly the course of a year. The further along we go in the calendar, the greater the positive offset the U.S. economy experiences. The oil and natural gas industry contributes approximately eight percent to the U.S. GDP and supports around 10.3 million American jobs. The United States is the world’s largest oil producer and has held that position for the past six years. In 2024, the United States produced a record 13.2 million barrels per day (mbpd). (Russia, Saudi Arabia, and Iran produced 10.3, 9.0, and 3.25 mbpd in 2024, respectively.)
In theory, higher oil prices contribute to increased investment and an increase in economic activity, specifically in Texas, North Dakota, and Oklahoma.
However, A) households feel the effects first, and B) oil companies are reluctant to invest in new plants and expansion because their definition of a “sustained” rise in prices differs from ours. Companies need to experience higher prices for a longer time before they open their pocketbook to invest; however, our wallets are painfully forced to open much sooner. Net-net, higher oil prices are a negative in the short run, but they balance out somewhat more in the long run.
But there is another concern. As mentioned earlier, households spend about $2,500 a year on gasoline. That is not as much as the $13,000 per year they spend on groceries; however, filling up the tank is typically the most significant one-item weekly expenditure, and it stands out to buyers. It is a destination purchase, and even when we are not buying it, we are seeing mini-billboards of the price multiple times on every drive.
The correlation coefficient between gasoline prices and households’ expected inflation is significant. For the stats nerds out there, we are talking more than 0.8 by some metrics. Rising inflation expectations generally precede a rise in actual inflation on a one-to-one basis (not to delve into the weeds, but wages are a key connection between the two). Inflation is an economic headwind because it erodes purchasing power and causes the Federal Reserve to maintain a restrictive monetary policy.
The takeaway is that although things may equalize in the long run, higher oil prices are a headwind for the economy and the stock market now. The S&P 500 stock market index is trading at about 6,000. It first crossed that level in November 2024, seven months ago. I remember the index first hitting 2,000 in 2014. It took nearly two years for it to break out past 2,000 and never look back. Will higher oil prices and a resurgence of inflation keep the stock market flat for another 18 months—until 2027?
In 2014, the significant headwind that kept the stock market flat was a lack of earnings growth. What could cause earnings growth to be lackluster in the coming years? Higher tariffs? Higher wages due to less labor supply? A resurgence of inflation keeping the Fed’s monetary policy restrictive? All three of those are boogeymen for the stock market.
I am not currently worried about a bear market, but I am not thrilled about the prospects of stock prices stagnating.
Allen Harris is an owner of Berkshire Money Management in Great Barrington, MA, and Dalton, MA, managing more than $700 million of investments. Unless specifically identified as original research or data gathering, some or all of the data cited is attributable to third-party sources. Unless stated otherwise, any mention of specific securities or investments is for illustrative purposes only. Advisor’s clients may or may not hold the securities discussed in their portfolios. Advisor makes no representation that any of the securities discussed have been or will be profitable. Full disclosures: https://berkshiremm.com/capital-ideas-disclosures/ Direct inquiries to Allen at AHarris@BerkshireMM.com.
