Driving to Tehran

US equity markets barely budged on news of President Trump’s decision to withdraw from the Iran nuclear deal, and we are not surprised at this mid-afternoon yawn of a response. Investors have caught on to the president’s negotiating style: start big with a splashy announcement, but then quietly let the status quo prevail. Remember NAFTA, a.k.a. “the worst trade deal in history”? Negotiations continue there, with the latest round of talks in Washington this week. In the meantime, trade between Mexico, Canada and the US continues pretty much as if nothing ever happened.

At the same time, today’s events are a good reason to review US gasoline prices, something that really does matter to consumer confidence/spending and therefore stock prices. If you live in an urban area and don’t use a personal car every day, you may be surprised to know that:

• Americans drive 3.2 trillion miles every year, the equivalent of +17,000 round trips between the Sun and Earth.

• 85% of American workers commute to and from work, alone, in their personal vehicle and this is the #1 use of cars and light trucks in the US.

• In 2017, the US consumed 144 billion gallons of gasoline, or 391 million gallons per day. Put another way, on average every American uses 1.2 gallons of gas every day, enough power to move the typical new car +25 miles down the road.

• There’s a myth out there that Americans are driving less; they aren’t. Miles driven rose 1.2% last year versus 2016 according the DOT, more than population growth. Gasoline consumption is also up; net tax receipts to the US Highway Trust Fund (which come from a fixed gasoline tax) are up 1.8% in the current fiscal year through March.

Shifting to economic/markets issues, only one question really matters: “What is the US consumer’s breaking point when it comes to higher gas prices?” Our take here in three points:

#1. The speed of any increases matters as much as the absolute level. Crude oil prices more than doubled in the 3 months from June 1990 ($17/barrel) to September 1990 ($40/barrel) with Iraq’s invasion of Kuwait, and the result was a recession. Oil prices also doubled in the mid-2000s, from $31/barrel in July 2003 to $61 in July 2005, but that happened over 24 months instead of 3 in 1990. Consumers adapted to the change, and there was no recession.

What helped push the US economy over the cliff in 2008 aside from the Financial Crisis was the next double, which happened in 12 months from June 2007 ($70/barrel) to May 2008 ($140/barrel).

On this count, oil prices are up 52% over the past year, so we are not yet close to that “100% in a year or less” rate of change that history shows is a clear warning sign. Also, even at $70/barrel, oil prices are no worse than 2006/2007 and well below the +$100/barrel of 2011-2014. US labor markets are stronger than either of those periods, and the domestic economy is on better footing as well.

#2. Seasonality plays an important role in gasoline prices. One good reason to worry about gas prices just now (point #1 notwithstanding) is that summer brings holiday driving. That incremental demand tends to boost prices by 10-30% (the historical data is very choppy) from April/May through August/September.

All this means one thing: markets will be looking for a go-slow approach from Washington on Iran to get through the 2018 summer driving season. The current agreement has 90 and 180 wind down periods before sanctions go back into place. Investors will also be looking to see how Washington deals with allies that plan to still hold to the agreement. If they are still allowed to purchase Iranian crude, the effect on global prices will be much smaller than if the US takes a hard line on this point.

#3. Regional differences are large. While markets focus on the price of untaxed regular gasoline (RBOB Gas), there are large differences across the country. California, the single most important state to the US economy, currently has an average gas price of $3.64 according to AAA. That is 40% higher than average prices in Texas, for example.

Summing up: for all the headlines about Iran, we do not see oil prices crimping consumer confidence and therefore the US economy in the near term. Yes, gas prices are higher and they will likely ramp into summer driving season as they always do. The US economy is strong enough to pay them, and there has not been a sufficiently large shock in prices to signal concern.

We have some margin of safety on this idea: oil prices would have to hit $84/barrel in June to breach our “100% in a year” warning sign. While anything is possible, we don’t see that happening.