This has certainly been a year of firsts for investors. We've witnessed the largest single-day point decline in history for the Dow Jones Industrial Average and observed a marijuana stock uplist from the over-the-counter exchange to the Nasdaq. More recently, we've watched as West Texas Intermediate crude pushed to its highest levels since November 2014, hitting more than $68 per barrel as of Friday, April 20, 2018.

This latter figure is especially intriguing as it could encourage an uptick in domestic and offshore drilling demand, which has been substantially curtailed since oil prices fell off a cliff in 2014 and subsequently plunged around 75% from peak-to-trough over a one-and-a-half-year span.

But this steady rise in oil prices shouldn't just be exciting to oil companies and investors. It should also put smiles on the faces of Social Security recipients.

Two oil pumps operating at sunset.

Image source: Getty Images.

Annual cost-of-living adjustments are very important to Social Security recipients

Social Security is a program that, according to the Social Security Administration (SSA), provides a guaranteed benefit to 62.2 million people each month, as of March 2018. Almost 69% of these recipients (42.8 million) are retired workers, and of them, 62% lean on Social Security to account for at least half of their monthly income. In other words, it's a vital program that many would struggle to live without.

Since most retired workers rely on Social Security for a large portion of their income, the SSA's announcement in mid-October regarding the following year's cost-of-living adjustment, or COLA, is a highly anticipated event. COLA is the "raise" that beneficiaries receive each year, and Social Security recipients want to know how much extra they'll be receiving each month the following year compared to the current year.

COLA is determined by examining Social Security's inflationary tether, the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W). The average reading from the third quarter (July through September) of the previous year serves as the baseline, while the average reading from the third quarter of the current year is the comparison. If the average price of the goods and services measured by the CPI-W has increased, then Social Security recipients receive that difference, expressed as a percentage and rounded to the nearest 0.1%, as a raise the following year. Deflation, thankfully, won't cause a decline in benefits -- if prices have fallen, benefits remain static from one year to the next. 

A smiling senior man.

Image source: Getty Images.

Why rising oil prices should matter to Social Security beneficiaries

The CPI-W takes into account eight major spending categories:

  1. Food and beverages
  2. Housing
  3. Apparel
  4. Transportation
  5. Medical care
  6. Recreation
  7. Education and communication
  8. Other goods and services

The price of oil can have a profound impact on a few of these categories. For instance, the rising price of WTI crude is expected to push summer gasoline prices to their highest level since 2014, according to fuel-price analysts. Gasoline is a component of the transportation category, and played a key role in pushing Social Security's COLA up 2% in 2018.

Last year, hurricanes Harvey and Irma wound up shutting down refineries in the southern U.S. and Gulf of Mexico, straining gasoline supply and substantially pushing up gasoline prices in August and September -- two of the three months that factor into the annual COLA calculation. While this meant a slightly bigger raise than expected for Social Security recipients, it also makes for a very tough year-on-year comparison in the upcoming third quarter. We obviously have no clue what the 2018 hurricane season will bring, or how that might impact gasoline prices. However, with WTI crude substantially higher now than it was a year ago, there's a real shot for gasoline price inflation to have a positive impact on COLA for 2019, even if the hurricane season is tame.

It's also worth pointing out that oil prices can also have an effect on housing expenditures via fuel oil costs.

Since transportation expenditures impact seniors far less than working-age Americans, the rising price of WTI crude appears to be a clear positive for seniors receiving Social Security income.

Scissors cutting through a hundred dollar bill.

Image source: Getty Images.

No quick fix for this

However, the rising price of oil isn't going to make much of a dent in the long-term purchasing power declines that seniors have been contending with. The CPI-W, as the name implies, factors in the spending habits of working-age urban and clerical workers. As you might imagine, the spending habits of urban and clerical workers are nothing like those of seniors. A comparison of the two shows that seniors spend considerably more on medical care, and modestly more on housing costs, than urban and clerical workers. But the CPI-W places more emphasis on transportation, apparel, food and beverages, and education, which, in aggregate, simply isn't that large an expense for seniors.

The result? According to The Senior Citizens League, the purchasing power of Social Security benefits has fallen by 30% since 2000. That's a trend that likely won't reverse anytime soon, either. 

One solution, often proposed by Democrats in Congress, is to switch the inflationary tether away from the CPI-W and to the Consumer Price Index for the Elderly, or CPI-E. As the name suggests, it would track the expenditures of households with persons aged 62 and over. While this metric would more accurately reflect the inflation that seniors are facing, it would still come with two drawbacks.

First, the CPI-E fails to account for Medicare Part A (hospital insurance) expenditures, meaning medical care inflation would still be underreported for most retired workers.

Secondly, while potentially boosting COLA for beneficiaries, it'd work to drain the asset reserves of the Social Security Trust even faster. The Social Security Board of Trustees has projected a depletion of the $3 trillion in asset reserves by 2034, whereby an across-the-board cut of up to 23% might be needed to keep the program solvent through 2091. If annual raises get bumped higher by switching to the CPI-E, the need for sweeping cuts may come sooner than expected. 

In sum, while the rising price of oil should have Social Security beneficiaries excited about next year's COLA, the crude reality is that benefits are still expected to lose purchasing power over the long term.