- President Donald Trump announced that the US will leave the Iran nuclear deal.
- Trump’s decision is projected to remove 250,000 to 500,000 barrels per day of Iranian oil from the market.
- The decrease in oil supply will likely increase prices and eventually cause US gas prices to rise.
- The bump in gas prices could eat into US households’ discretionary income.
President Donald Trump’s decision to pull the US out of the Iran nuclear deal is likely to have major economic consequences, even potentially scuttling the boost from the GOP tax law for Americans’ wages.
By leaving the Iran deal, Trump would limit access to oil from the country and make a large piece of the global supply unavailable in the US. In turn, this would likely help drive gas prices higher. And as analysts have noted, gas prices don’t need to climb much to eat up a large portion of the discretionary spending savings from the GOP tax law.
Let’s first look at the Iranian supply of oil
Damien Courvalin and Jeffrey Currie, analysts at Goldman Sachs, say between 250,000 and 500,000 barrels per day could be subject to US sanctions and pulled off the market. That would boost oil prices anywhere from $US3.50 to $US7 per barrel above their current trajectory, the analysts said.
Restricted supply from Venezuela and a rebalancing of global supply have boosted the price of oil over the past two years, with West Texas Intermediate (the US benchmark) hovering around $US70 a barrel. Pulling out the Iran deal will add more upward pressure to these prices.
Over the past year, the average price of a gallon of gas increased from $US2.52 to $US2.96. Ellen Zentner, a Morgan Stanley economist, said the increase could eat into a substantial portion of the average household’s gains from the tax law if it sustained over the rest of 2018.
“If we flat line the current gas price over the course of this year to reflect a sustained impact, the average price per gallon of gasoline will be about 36 cents higher this year compared with last year’s average,” Zentner wrote in a note to clients Tuesday. “That ‘steals’ about an annualized $US38 billion in spending from elsewhere, or roughly one-third of the benefit to households from lower withholding.”
While the higher gas prices would already consume a substantial percentage of the wage gain from the new tax law, a further increase could wipe out the benefit altogether, said Matthew Luzzetti, senior economist at Deutsche Bank.
“Referring to the above relationship between gas prices and spending on energy items, the former would have to rise by a sustained $US1.05 per gallon to completely offset the aggregate disposable income gains from tax cuts,” Luzzetti wrote in a note to clients.
Such a gas price jump would necessitate a huge increase in oil prices
The 36-cent gas price increase over the past year coincided with a roughly $US25 per barrel jump in oil – but even a smaller bump could tie up a significant amount of the tax law’s benefits.
According to the US Energy Information Administration, a decent rule of thumb is that every $US1 move in crude oil corresponds to a 2.4 cent move in the price of gas. The Federal Reserve Bank of St. Louis also found a similar correlation. So a $US7 boost in crude prices, per Goldman’s estimate, would bump gas prices 16.8 cents per gallon.
Since a $US1 increase in gas prices soaks up all of the tax law’s boost, just pulling out the Iran deal would absorb 16.8% of the financial benefits. This is obviously a rough estimate, but it illustrates the possible economic consequences of the president’s decision for average Americans.
Greg Daco, chief US economist at Oxford Economics, found that a large portion of the economic boost from both the new tax law and the bipartisan omnibus spending bill is at risk even if crude oil maintains its current price.
“We estimate that the Tax Cuts and Jobs Act and the Bipartisan Budget Act will contribute 0.7 percentage points to GDP growth in 2018, but if WTI crude prices average $US70 per barrel this year, this could offset half of the fiscal boost in 2018,” Daco wrote Tuesday.
But other suppliers could offset the lost Iranian oil. For instance, OPEC producers like Saudi Arabia could increase production, or US shale producers could being some of their capacity back online to make up the supply drop. This would keep prices low and mitigate the pain from pulling out of the nuclear deal.
Treasury Secretary Steven Mnuchin attempted to get out in front of concerns during a press conference on Tuesday, telling reports that other oil producers would step in to fill the void.
“Without commenting on specifics, we have had various conversations with various parties about different parties that would be willing to increase oil supply to offset this,” Mnuchin said.
Additionally, Trump’s decision to remove the US from the Iran deal was not an economic move first and foremost. So the possible oil price increase – and the trickle down effects for the US economy – is at best a secondary concern.
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