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Is there life after $50 a barrel? How oil prices affect economy

By The Christian Science Monitor and Dallas Morning News

DAVID J. PHILLIP / AP Traffic travels yesterday along Highway 225 near a refinery near Houston.

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If prices do stay high, they will act as a brake on the economy, by some economists' estimates, lowering growth in the year ahead by as much as a full percentage point. The timing is awkward: In another month, merchants hope, consumers will be thinking about holiday gifts, not their fuel bills.

The hit on households

The $50 price tag is more than just a psychological marker.

A year ago, oil cost $26 a barrel. That premium translates into real money taken out of corporate budgets and family pocketbooks. In an $11 trillion economy, that's about $902 per U.S. household.

"The number one issue facing the customer today is, in fact, energy prices," said Lee Scott, chief executive officer of Wal-Mart Stores, at an analyst conference earlier this month.

Although oil is at an all-time high, prices are not at record levels when inflation is taken into account. Adjusting for inflation, today's prices are still more than $30 below the level reached in 1981 after the Iranian revolution.

That hasn't eased the fears gripping the market, however.

Although oil prices have been high for some time, the latest push is the result of a combination of events. There is enough geopolitical uncertainty from Iraq to Nigeria to keep the oil markets nervous. The U.S. oil industry is still recovering from the damage done by Hurricane Ivan, which not only knocked out some production in the Gulf of Mexico but also kept tankers from unloading imports in New Orleans and Galveston, Texas. This has resulted in a sharp drop in U.S. inventories to their lowest level in 30 years.

"We won't see any real relief, any respite, until we see some increase in U.S. crude inventories," says John Kilduff, a trader at FIMAT USA.

What's next?

How high can prices go? Kilduff envisions short-term oil prices of $51 to $53 a barrel. And he says $60 per barrel is not out of the question "if Iraq worsens and some other disruptions take place."

Over the longer term, some analysts see prices retreating as the high prices encourage nations to produce oil and demand starts to recede. "EIA's views is still that prices will drop below $40 a barrel by the end of next year," says Erik Kreil, an analyst at the Energy Information Administration (EIA) in Washington, D.C.

Yesterday, even the news that Saudi Arabia would increase its production to 11 million barrels of oil per day did not immediately reduce prices. Oil traders say they will have to see the production first to believe the ramp-up is possible.

"This is a Saudi misstep; Aramco [the Saudi national oil company] said earlier that the additional production wouldn't be on line until the end of the year," says Kilduff.

Another factor in the oil equation is the spurt in global demand — almost an additional 2.5 million barrels per day. Much of this is moving to China, where there is a combination of economic growth and the nation's build-up of its own strategic petroleum reserve.

A reflection of this demand is a tight tanker market, which is raising the price of transporting oil.

Clues to what high oil prices mean for the overall economy can be seen in the rear-view mirror.

Second-quarter economic data, including consumer spending, fell short of expectations — largely because of a run-up in crude this spring.

"The recovery has been disappointing in large part because energy prices have risen to such a degree," said Mark Zandi, chief economist at Economy.com in West Chester, Pa. "The recovery would have been measurably stronger and have created more jobs if we didn't have to pay for such energy increases."

David Wyss, chief economist at Standard & Poor's in New York, thinks the high energy prices will take about a full percentage point off the nation's gross domestic product next year. And, he says, "Christmas is going to be affected. We can only hope for global warming."

More proof of energy-induced economic weakness might be had at the end of this week when the government releases the latest batch of personal income and consumer-spending data.

In the past, high oil prices have preceded recessions. For example, in 1979, oil peaked at about $75 in today's dollars and that led to a recession in 1980.

Economist Bob Brusca of FAO Economics in New York says the high prices may prompt the Federal Reserve and other central banks to reconsider their tighter monetary policies. "If all the central banks stay on the side of tightness, it makes a slump more likely," he said.

Still, economists don't expect $50 oil to send the economy into recession.

Corporations have been able to offset the increases with productivity gains. Levels would have to reach $70 or $80 a barrel to do real damage, they said.

That being said, oil is not headed for the discount bin any time soon. And this will continue to wreak havoc on already struggling airlines.

Every one-cent increase in jet fuel prices raises American Airlines Inc.'s annual fuel expenses by nearly $33 million. The carrier will spend more than $1 billion more for jet kerosene in 2004 than it did in 2003, which historically was a high-cost year for jet fuel.

Auto dealers are already starting to feel the impact of consumer hesitation. According to Ward's AutoInfoBank, U.S. car sales are down by 3 percent for January through August of this year, compared with the same period last year. But ironically, light-truck sales are up 2.9 percent.

"The single most watched price in the world is the price of gasoline," said Ray Perryman, economist at the Perryman Group in Waco, Texas.

Gasoline prices stable

One silver lining for consumers: Gasoline prices have remained remarkably stable even as crude prices have skyrocketed.

The average price of a gallon of regular unleaded in Washington was $2.01 Monday, according to the Department of Energy. That is just 2 cents more than the $1.99 average Aug. 30, and well below the $.2.29 peak recorded May 24.

For the entire U.S., the average gasoline price was $1.92.

Current gasoline prices are especially noteworthy because the price of a barrel of crude was $42 per barrel when gas prices spiked in May, which was well below the nearly $50 per barrel crude is fetching now.

Energy-industry analysts attribute the disconnect between gas prices and crude prices to lower demand; U.S. gasoline consumption spikes during the summer driving season then drops off markedly in the fall.

Looking toward winter

Home heating has been a major concern for consumers, says Maureen Sclafani, co-owner of Liberty Petroleum and Sclafani Petroleum. She says that gallon sales, on average, are down by about a third. It's been that way for about six months.

"This is normally a pickup time of year," she says. "It's not picking up."

That may be because the price is so high and consumers are waiting to see if it will drop. The cash-on-delivery price is around $1.70 — among the highest Sclafani's seen for October in 15 years. The only other comparable price was once during the Gulf War.

Seattle Times staff reporter David Bowermaster contributed information on gas prices.

Copyright © 2004 The Seattle Times Company

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