Posted on 09/30/2007 12:13:43 AM PDT by TigerLikesRooster
How Economy Could Survive Oil At $100 A Barrel
The world economy has managed, with some indigestion, to swallow the rise of oil prices past $80 a barrel. How well could it survive $100 a barrel? The answer is quite well -- so long as several conditions still hold true. The price rise would probably have to be gradual. Inflation couldn't get so bad as to force big interest-rate hikes. Oil-rich nations would need to pump their profits back into U.S. and European economies.
All of this has happened so far. The happy confluence may continue, though fears remain strong that high energy prices will tip the U.S. into recession. A host of factors, including tight oil supplies and a weak U.S. dollar, suggest that oil prices have further to rise. Some analysts continue to believe that oil is destined to reach an all-time high, as measured in today's dollars, of more than $101 a barrel.
The record was set in 1980. On Friday in New York, the benchmark crude-oil futures price closed down $1.22, or 1.5%, to finish at $81.66, a little more than $2 off the all-time high, not adjusting for inflation.
High oil prices could lead to ugly consequences if they hit consumers' pocketbooks -- especially in the U.S., where the housing slump is already hurting the economy. Consumer spending has been the primary engine of growth in the U.S. in recent years. Target Corp. was among the major retailers in the last week cutting sales forecasts.
Target expects September sales at stores open at least a year to rise just 1.5% to 2.5%, down from an earlier expectation of 4% to 6% growth. For all the concern, the world today is better equipped to swallow expensive oil than it was when Jimmy Carter was installing solar panels and a wood-burning stove in the White House. The main reason has to do with what some call the Wal-Mart effect.
For every extra dollar taken from drivers' pockets at the pump in the form of higher prices in recent years, low-cost exporters from China and elsewhere have put roughly $1.50 back in the form of cheaper retail goods. Even at today's near-record prices, U.S. households today spend less than 4% of their disposable income at the pump, vs. over 6% in 1980.
Current prices are also a reflection of a strong economy, not an oil embargo or war in the Middle East. Since a market-share war between Saudi Arabia and Venezuela flooded the market with oil and drove prices to below $11 a barrel in 1998, oil prices have risen nearly eight-fold. During that run, the global economy grew roughly 5% each year.
Strong growth in places like China helps take some of the edge off the oil-price blow for U.S. and European companies such as Detroit's Big Three auto makers. Many emerging markets are hitting a "takeoff" stage, where per-capita income reaches a level that sparks serious auto demand, says Ellen Hughes-Cromwick, Ford Motor Co.'s chief economist. Growth in emerging markets is a "structural development" that is "less sensitive to oil-price changes," she says.
"There's a more relaxed attitude now," said Daniel Yergin, a noted oil historian and chairman of Cambridge Energy Research Associates. At a recent event promoting Alan Greenspan's new memoir, Mr. Yergin asked the former Fed chief on stage if $80 oil was a concern. "
He basically shrugged and said, 'Not so far,'" Mr. Yergin recalls. Economists see global growth slowing but still chugging along at a relatively healthy 3% this year and next. High oil prices also mean more money for oil-producing nations such as Russia and Saudi Arabia to invest globally.
"If resource owners are now getting a bigger piece of the pie to spend and invest, then $100 oil shouldn't be a problem" in the absence of a U.S. recession, says independent energy economist Philip Verleger Jr. "And that investment is happening." Such sanguine views, while they are far from universal, reflect a fundamental shift in economists' understanding of how energy prices affect the economy.
Historically, oil prices have doubled or trebled in a matter of weeks because of sudden and sharp supply disruptions, such as those in 1980 following the Iranian revolution and the outbreak of the Iran-Iraq war.
That prompted the Fed to raise interest rates sharply in an effort to head off a spiral of inflation. Current Fed chairman Ben Bernanke has spent a lot of time trying to understand such shocks.
In 1997, he analyzed the effects of sharp rise in prices during the oil shocks of 1973-75, 1980-1982 and 1990-91 in the Brookings Papers on Economic Activity. His surprising conclusion: The Fed's cure for high oil prices was worse than the disease.
"The majority of the impact of an oil price shock on the real economy is attributable to the central bank's response to the inflationary pressures engendered by the shock," he wrote. Today, that view is fairly mainstream among central bankers. Mr. Bernanke's Fed recently responded to the subprime mortgage crisis by cutting benchmark interest rates for the first time in four years.
By implication, the Fed was saying it was more worried about the fallout from credit-market gloom than about the risk of inflation. At a time of record energy prices, that's a risky but educated bet. Growing fuel efficiency could also blunt the blow of higher prices.
James Barnes, a Union Pacific Corp. spokesman, says the railroad has bought more fuel-efficient locomotives and trained engineers to operate trains in ways that conserve fuel. "From a macro level, we would anticipate that rising oil costs will make us more competitive [with trucks] and potentially drive more business our way," Mr. Barnes says.
In China, the engine of growth on which many are counting, other energy sources can make up for oil. China uses oil for only 21% of its energy needs, with most of the rest coming from coal.
Unlike in the U.S., where imported oil goes to fill people's gasoline tanks, China mainly uses oil in industrial settings, where coal may be an alternative. Greater coal use, however, would also exacerbate China's already serious pollution problem and speed up emissions of gases that contribute to global warming. Still, some fear the impact of $100-a-barrel oil would be too powerful for the U.S. to overcome.
"If we aren't already headed for a recession, it could push us in that direction," says Bill Zollars, chairman and chief executive officer of YRC Worldwide Inc., a large trucking company based in Overland Park, Kan. "With a very fragile economy like we have now, this could be another burden for the consumer and the business community."
Mr. Zollars says shipment volumes at YRC, which serves many retailers and manufacturers, have dropped to 2003 levels. "We are not seeing the kind of volume we would normally expect" ahead of the Christmas retail season, he adds. Higher oil prices could hit the beleaguered auto and airline industries.
Detroit is still digging out from the fall in demand for sport-utility vehicles caused by the climb in gasoline prices. Paul Ballew, General Motors Corp.'s top sales analyst, explained sluggish industry sales earlier this month by citing in part high fuel prices, which he called "effectively a tax on U.S. households."
For now, most economists expect oil prices will stay high through next year. An unexpected hurricane in the Gulf or a sudden disruption to oil flows from a big producer like Iran or Mexico could push oil to $100, they say.
Demand is chugging along. The Paris-based International Energy Agency sees world oil demand in the fourth quarter rising by 2.8%, or 2.3 million barrels a day from a year ago, to nearly 88 million barrels a day.
Of course, those forecasts could go awry if the U.S. economy tanks and brings Europe and Japan along with it. Then demand would likely ease, and oil prices could fall, perhaps significantly. And then, the world would have something else to worry about.
OPEC is actually pretty desperate to get the price of oil back down to about $50/bbl or so (IIRC). The problem they see is that an *awful* lot of alternate oil extraction processes become economically viable beyond that point. At $100/bbl, almost *all* the alternatives become economically viable.
And once we shift away from OPEC oil because the alternatives are suddenly viable, we won’t be coming back. Neither will all the other customers that leave. Supply and demand will ensure that these alternatives’ prices continue to drop, and we won’t be beholden to OPEC or the ME any more.
OPEC is more scared of that than anything else.
I read this previously at the WSJ. What struck me was no mention of the ruinous trade deficits from the “Wal Mart effect”. What dopey thinking. I rate this article a 0 out of 10.
Wishful thinking as you put it. Quite infantile since the last month has the USDollar crashing due to trade deficits.
In my remote area, most people (mostly working class) continue to drive daily over 60 miles each way through mountainous terrain to the city for the purpose of avoiding boredom. After the neighbors arrive home during the evenings, the bear, attracted by junk food wrappers and residue, break into their vehicles.
The fear of 100 dollars a barrel must be affecting your spelling!....;)
I love the smell of burning democrats in the morning!
Interesting take on the situation. I hope that the OPEC powers that be are business savvy enough to realize this artificially high oil price is going to ultimately lead to alternative energy sources. Keeping the price of oil high is ultimately going to lead to their demise. History seems to show that OPEC is operating from more of a thug mentality than good a good business model. I hope you are correct in your assessment.
“... U.S. households today spend less than 4% of their disposable income at the pump, vs. over 6% in 1980.”
I strongly question that statement. My personal number is close to 10% but I have four vehicles and two teenage drivers. In any case, I’ll bet anyone with more than one vehicle is well over 4% also, unless you walk to work.
I also agree that OPEC would rather not have oil at $100bbl because of alternative fuel viability.
This could be a meager Christmas season for retailers. Not only are millions of consumers tapped out and their credit cards reaching their limits due to escalating gas and food prices, but no one is excited about buying dangerous cheap toys, clothing, etc. from China or plunking down cash they don’t have for over-priced electronic gadgets.
The materialistic buying frenzy to celebrate the Lord’s birth has always been unseemly. This may be a good time to pull the plug on it and think of ways you can show your children and grandchildren you love them by spending time with them (fishing trips, going to a ballgame, taking a trip to visit a relative in a distant place with them) instead of buying them stuff that will be broken or thrown in an over-stuffed closet after the holidays, leaving them with no memories and you with a credit card bill to pay.
Iran is driving the price of oil. Oil will continue to rise until Iran is settled because fear of supply constraints puts pressure on demand in the futures market.
For those who don’t understand how we can not have an immediate shortage and yet have increased demand, think of what would happen to the price of food if it were announced that there was a 50% chance than an asteroid would hit in three years. The futures price would jump 100-500% and the current price would follow (as it always does).
When the Iran issue is settled, oil will drop to $40-50 within six months. If the oil states respond to the cut in revenue by boosting production, it will drop even further.
Good. I’d gladly pay $4 for alternative fuels made in the USA and give OPEC the finger.
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