A surge in oil prices sparked by saber-rattling from Iran is beginning to weigh on the global economic recovery, with potential ripple effects on consumers, corporate profits and interest rates.
Drivers already are seeing the impact at the pump, where prices have risen by an average of 12 cents per gallon in just three weeks to more than $3.50 a gallon, according to a report out this week. Crude oil prices rose for a third straight day on U.S. markets Friday, topping $103 a barrel, and remained on track for a second straight week of gains.
The cost of crude has been rising steadily since hitting a seasonal low in October, gaining upward momentum on escalating tensions with Iran after a series of moves by the U.S. and European Union to pressure Tehran to shut down a uranium enrichment program aimed at producing nuclear weapons.
The moves sparked fears among oil traders that Iran, the world's fifth-largest oil producer, may retaliate by disrupting the flow of oil through a critical Persian Gulf shipping channel.
"The Iranians have a lot at their disposal to upset this market, whether by embargoing the (European Union) or even just creating some mischief," said oil industry analyst John Kilduff. "They don't even have to block the Strait of Hormuz, they just need to sink a ship, lay some mines and be disruptive."
As Western nations bent on denying Iran access to nuclear weapons have ratcheted up the pressure, traders have been busy bidding up oil and gasoline prices. Last week, more than 350,000 gasoline contracts were open (each contract represents 1,000 barrels of oil) as hedge funds and commodity investors placed heavy bets that pump prices are heading even higher. Traders expecting prices to move higher bet some $10 billion more than those who see prices falling, the third-largest skew of all time, according to Tom Kloza, president of Oil Price Information Service.
The timing of the price spike for crude comes just as oil refiners are getting ready to switch production from blending gasoline for winter use to building inventories formulated for summer consumption. That switch typically involves temporary refinery shutdowns that have pinched supplies in the past. That could produce a larger-than-normal spike this year when the summer driving season rolls around.
Pump price jumped 0.9 percent in January alone, helping to fuel a 0.2 percent increase in the Consumer Price Index, the Labor Department reported Friday.
Higher driving costs are hitting consumers just as they're beginning to catch a break balancing their households budgets. Stronger job growth and longer hours have helped boost worker paychecks in the past six months. Household incomes will continue to benefit from a payroll tax cut and long-term jobless benefits, which Congress on Friday agreed to extend through the rest of the year.
But that economic boost could be wiped out by another surge in gasoline prices: Every added penny at the pump diverts roughly $1 billion in consumer spending from other sectors of the economy. Gas prices peaked last year in May just shy of $4 a gallon, on average, and had been falling steadily before reversing course. Last week, the average price of a gallon of regular was $3.52, according to the Energy Information Administration.
Friday's consumer price data also showed that the cost of all goods rose an unexpectedly steep 2.3 percent over the past 12 months. On top of higher gasoline prices, household budgets have also been squeezed by higher prices for food, clothing, health care and education.
“While inflation has moderated, it is still higher enough to wipe out worker earnings,” said Joel Naroff, chief economist at Naroff Economic Advisors. "Even the moderate earnings growth is still not enough to improve consumer spending power a whole lot."
Businesses also are feeling the pinch, especially heavy energy users such as airlines, shipping companies and chemical manufacturers. Many of those companies, though, have figured out how to pass along their higher costs to consumers.
A temporary spike in oil and gasoline prices would be unlikely to have a lasting impact on the U.S. economy. If worries about the standoff with Iran subside, prices should ease back fairly quickly. U.S. crude inventories are near five-year highs for this time of year. While the gathering strength in the U.S. economy could push demand higher, that will likely be offset by the widening economic slowdown in Europe.
A longer-term rise in oil prices, though, could present problems for policymakers at the Federal Reserve, as they mull their next steps in trying to keep the economic recovery on track.
The Fed last month said it plans to hold its benchmark interest rate at a record low near zero until late 2014. That pledge could be hard to keep if inflation were to begin a sustained move upward. The Fed is forecasting that inflation will rise just 1.6 percent this year, below its target of 2 percent. Fed Chairman Ben Bernanke announced that target, the first ever for the central bank, last month.
But the Fed's forecasts don't assume a sustained period of elevated oil prices. Until the standoff is resolved between Western nations and Iran, those inflation forecasts will be more difficult to make.
That standoff could take months to play out.
Last month, the U.S. imposed sanctions on foreign banks financing Iranian oil sales, and the Obama administration is deciding how widely to apply them. Congress is considering wider actions, including a ban on ships that have docked in Iran, North Korea or Syria in the last two years; and sanctioning private companies involved in Iran's oil industry.
As part of its coordinated campaign with other countries, the European Union last month imposed an embargo on Iranian oil that takes effect July 1. Since then, European countries have been making arrangements to secure other sources of supply.