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Extra
Get ready for $50 oil
Supply is shaky as ever, demand is relentless and heating season just is around the corner. Here's what the daily march into record territory means at the gas pump and to the economy.
By Kim Khan
Most people have never bought a barrel of crude oil. But as the price closes in on $50, everybody will know exactly what it costs.
New York crude oil futures have surged above $49 per barrel already -- $7 above the most recent peak set in early summer -- and almost every day has brought a new record. Suddenly oil $50 per barrel is within reach, a number unthinkable at the beginning of the year.
The oil market is the tightest it has been since the eve of the oil shock in 1973, and any disruption in supply could lead to prices spiking even further, says Dan Yergin, CNBC global energy expert.
With little abatement in world demand, persistent supply concerns with Iraq and Russia, and OPEC pumping at near capacity, theres little relief in sight.
So what does such a whopping price for oil mean to your finances?
- Gas. Fuel prices would rise and put a further strain on household budgets.
- Inflation. High energy prices could spill over and put upward pressure on other consumer prices.
- Jobs. Companies concerned about runaway energy costs could refrain from hiring new workers.
- Interest rates. The Federal Reserve could raise rates at a faster pace to keep prices in check.
A full tank, an empty wallet
The most obvious place consumers feel the energy pinch is at the gas pump. Oddly enough, gas prices actually slid last week despite the recent run-up in crude. But dont expect that disconnect to last forever. Historically, gas prices have tracked crude prices.
Theres more of a lag between oil costs and pump prices in the summer than in the winter. During the summer months, when crude inventories are rising, prices arent passed down to the retail level as quickly, Jacques Rousseau, oil analyst at Friedman Billings Ramsey told CNBCs Morning Call recently. Instead, its the refiners that feel the pinch. In the winter, when inventories are drawn down, prices are passed on more quickly, Rousseau said.
Related news and commentary on MSN Money
No matter how quickly the cost is passed on, the fact remains that when consumers pay more at the pump, they have less to spend elsewhere. Gas at $2 a gallon costs a driver in a 15 mpg car driven 15,000 miles a year $500 more than gas at $1.50. A rule of thumb is that each $1 increase in the cost of crude adds 2.4 cents at the pump.
High energy prices act like a tax that lowers disposable income, Thorsten Fischer, energy economist at Economy.com, told CNBC.com. Individuals cant economize on energy in the short term, so they cut back other items, Fischer said.
Recent numbers indicate high gas prices have already curtailed the consumers appetite for other goods. Consumer spending for June fell 0.7%, compared to a 1% rise in May. That is the biggest drop since September 2001, when terrorists attacked the United States. The decline directly contributed to second-quarter gross domestic product (GDP) growing at an annual rate of 3%, well below the 3.7% growth rate expected.
But its important to keep in mind that spending on energy, while very visible, is a relatively small part of overall consumer spending, at 2.5% to 3%, Fischer said. And as of yet, prices of other goods are not following energys rapid rise.
The consumer is being choked by higher energy prices, but not strangled by higher energy prices, Anthony Chan, senior economist at J.P. Morgan Fleming Asset Management, told CNBC.com.
Will you pay more to fly or send a package?
There is a worry, though, that the high cost of oil will spill over into the rest of the economy. Automakers, airlines, paint manufacturers and overnight delivery companies are all very sensitive to the price of oil. If profit margins are squeezed further, they could pass the costs on to their customers.
So far, Corporate America has avoided this. Some, like airlines, simply dont have the pricing power to hike fares and ease energy pressures. Others are relying on increased productivity to help the bottom line. Naturally, small businesses feel the pressure more than companies that can hedge against rising fuel costs or have a lot of cash on hand.
(High oil prices are) a negative for growth, theres not doubt about it, Doug Porter, analyst at BMO Nesbitt Burns told CNBC. And it's not just the $50 level that matters. Its that prices have been rising steadily but surely for months now.
High energy prices are a tax on the economy and are slowing the economic growth rate, Treasury Secretary John Snow told CNBCs Squawk Box. But oil prices are something of a bubble and should recede as uncertainties are clarified, Snow said.
As long as other prices dont follow the energy inflation pattern, economists are confident economic growth can continue and recession will be avoided.
Rising energy prices, per se, wont be the death knell of the economy, but if they are passed on to the consumer in other areas, there will be trouble, said Chan at J.P. Morgan.
Yet another reason not to hire
Could expensive oil cost you a job? While high energy prices may not be slamming company profits just yet, rising oil can certainly affect corporate spending. And with companies still a bit reluctant to hire new workers, $50 oil could prevent investment in labor.
Facing a host of uncertainties -- oil, terrorism and the upcoming presidential election -- companies are not hiring like they need at this stage of the economic expansion, Sung Won Sohn, chief economist at Wells Fargo, told CNBCs Morning Call. The economy created just 32,000 jobs in July, well below the 215,000 economists expected and the 150,000 experts say are needed to keep the expansion going.
(Oil) is going to some extent affect hiring, with companies finding ways to save money to offset rising energy costs, Chan said. But (energy costs) are less than 2% of total business costs, while labor costs 65%. Its a question of magnitude.
Pay more for oil, pay more for housing?
Theres also an argument that $50 per barrel oil could eventually add to your monthly mortgage payment. Under Federal Reserve Chairman Alan Greenspan, the central bank has been vigilant in containing inflation.
Now, the Fed looks committed to raising interest rate a moderate pace, a quarter-point at a time. But if energy prices continue to rise and prompt a rise in prices for other goods, the Fed may prefer to put the brakes on a little faster.
As short-term interest rates rise, mortgage rates eventually follow suit.
The Fed always faces this dilemma, Economy.coms Fischer said. If energy prices go up, then the upward pressure on consumer prices raises the danger of inflation, which the Fed wants to preempt. On other hand, in addition to higher prices you also have slowing economic growth.
Faced with that choice, the Fed will likely keep tightening, as the first priority is to head off inflation, and sacrifice some growth, he added.
Pushing prices lower
Its tough to say what combination of factors could push oil prices down to more reasonable levels. Certainly, stability in Iraq and diminished terrorism worries would help. Analysts estimate as much as $10 per barrel on the price of oil is a premium put on the possibility of future attacks or supply disruptions.
The United States could decide to tap, or stop filling, the Strategic Petroleum Reserve. But that would be a stopgap measure, and President Bush is resistant to the idea.
The president made it clear the Strategic Petroleum Reserve is to be used for the purpose for which it was intended, a disruption of such proportions that its called for, Treasury Secretary Snow said. And ceasing to fill the SPR wouldnt change prices, he said.
Were filling it at a rate of 100,000 barrels per day in a market thats over 80 million barrels per day, Snow said. I dont think it would have much effect.
Dampening demand is another avenue, but it shows no signs of dying down, even at such high prices. One reason for this could be that, historically, oil is not as expensive as it seems.
Adjusted for inflation, oil would have to reach $57 per barrel to surpass its peak during the 1990 Gulf War. And it would have to jump to $80 per barrel to match prices seen during the 1978 and 1981 oil crunches.
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