Rise in oil prices seen as potential trigger of U.S. recession
By MICHAEL E. KANELL The Atlanta Journal-Constitution
The nation's economy is on the cusp once again of an energy crisis, a financial penalty that has repeatedly triggered recessions.
To be sure, the danger could dissipate within weeks, making energy instability a mere footnote to a smooth and satisfying resolution to tension in the Middle East and upheaval in Venezuela.
Or it may be that the Energy Crisis of 2003 has already begun. Certainly money has already been snatched from American pockets and shipped overseas, threatening an already fragile economic recovery.
Consumers are spending about $50 billion more in annual energy bills than a year ago, said Mark Zandi, chief economist for Economy.com. "And if we are spending more on gas and heating oil, we are spending less on everything else."
The burden is not borne equally. Costs are greater where it is coldest but also among the nation's less affluent, he said: A household below the median income spends an average of 8 percent on energy, compared with the national average of 5 percent, Zandi said.
Consumers account for two-thirds of the economy. But higher energy prices hit businesses, too, and their reluctance to spend already is the worst drag on an economy that has been struggling to recover from the 2001 recession.
Profits -- especially among transportation companies -- are increasingly squeezed by rising fuel prices. And manufacturers find it harder to sell in places like Europe, where more money must go to energy costs. Thinner margins and weaker revenue lead to cutbacks in hiring, investment and other spending.
Oil's global importance makes it all the more dangerous, argues Stephen Roach, chief economist at Morgan Stanley.
"Courtesy of a full-blown oil shock, the world is now flirting with yet another recession," Roach said.
Conventional wisdom expects -- and the Bush administration hopes for -- an Iraqi resolution that takes the air out of oil prices. But many businesses are not willing to bet on that, said Dorsey Farr, senior analyst at Balentine & Co.
"If war is prolonged, if oil prices change dramatically, you don't want to be the guy who went out on a limb and guessed wrong. It causes people to freeze, and the economy is feeling that right now."
Oil was going for $20 a barrel a year ago. This week, the price reached its highest level since the 1991 Gulf War, cresting near $40.
Pushing the price up is a cocktail of war anticipation, shortfalls in oil flowing from a politically embattled Venezuela and the unexpectedly high demand for heating oil in a surprisingly cold winter. And while the U.S. economy is not as dependent on energy as in 1973, the time of the Arab oil embargo, it remains vulnerable.
"It is already having a measurable negative impact," Zandi said. "And if we are still in the high $30s three months from now, we'll be in recession."
Predicting oil prices is a chancy game -- especially with war expected in the world's richest oil region. But a series of markers now warns of danger, just as they did in previous energy crises, according to a report by economists A.F. Alhajji of Ohio Northern University and James Williams, president of WTRG Economics.
Oil price spikes triggered or worsened downturns in 1973, 1979, 1990 and 2000.
The worst oil shocks -- 1973 and 1979 -- featured portents of trouble that are echoing now in:
• political turmoil in oil-producing countries;
• low supplies of oil in reserve;
• rising dependence on foreign oil;
• falling domestic production.
The Gulf War experience -- when prices rose rapidly only to fall nearly as fast -- shows that vulnerability does not always lead to crisis, Williams said. "But the current measures do indicate that the potential is historically high."
The potential comes not from just Iraq. Venezuelan production, undercut by near-revolution, has yet to recover to pre-crisis levels. Labor unrest has threatened Nigerian exports.
Foreign reliance higher
The United States, unlike Japan and most of Europe, has a huge oil industry. But U.S. production peaked in the 1970s after Alaska fields were tapped and has been declining since 1986.
Reliance on foreign sources reached record highs in the past two years.
At the time of the 1973 oil embargo, less than 35 percent of U.S. oil came from overseas, according to WTRG. That was nibbled down to 27 percent a dozen years later by a combination of domestic pumping and conservation.
U.S. imports now average about 8.3 million barrels per day -- roughly 60 percent of the nation's needs.
America's imported oil comes mostly from Canada, Saudi Arabia, Mexico, Venezuela, Nigeria and Iraq.
Good relations with producers don't really matter, since the oil market is what economists call "fungible." If a top U.S. supplier shuts down, oil could just be purchased elsewhere. But even the optimists think an attack on Iraq would suspend oil production, which now is more than 2 million barrels a day.
Shipments take time -- a month or more from the Middle East -- so short-term shortages are possible. And even when supplies can be shifted, a drop in supplies means higher prices.
So reliance on a small number of suppliers is worrisome. The top five account for about 76 percent of imports, up from 62 percent two years ago -- and about the same level as in 1990 when Iraq invaded Kuwait. During the 1979 crisis, five suppliers accounted for 53 percent, Williams said.
Counter to some public stereotypes, the Organization of Petroleum Exporting Countries has been quietly moving to expand production in the event of a war that even temporarily halts shipments of Iraqi crude.
Saudi Arabia, the main source of expanded production, can add more than 500,000 barrels a day, but turning on that spigot takes two to three months.
That mesh of factors has experts concerned.
"U.S. vulnerability to supply disruption has increased to historic levels recently," Williams said. "The U.S. is in no better shape to handle a supply interruption than it was at the time of the 1973 oil embargo, the Iranian revolution or the Iran-Iraq War."
Reserve levels low
Without oil, the nation's economic gears would grind to a stop.
Adding to the danger is the level of oil reserves held by U.S. companies: those stocks are at or near all-time lows. But while some critics charge that supplies are being manipulated to keep prices inflated, the dry tanks may be just a matter of good business. Despite the rising payments at the pump, many in the industry expect the world price of oil to drop soon after a U.S. attack on Iraq.
"And if you think prices are going to go down, you don't want to get stuck with high-priced inventory," Williams said.
Concerns about shortages were behind creation of the government's Strategic Petroleum Reserve. Right now, the reserve has about 600 million barrels of oil -- enough to replace about two months of imports. Meanwhile, commerical reserves have slipped to near-record lows.
Energy Secretary Spencer Abraham told Congress on Tuesday that the administration would tap the reserve if war threatens supplies.
But what if there is oil to be had, only at premium prices?
The 1973 oil embargo and 1979 Iranian revolution each more than doubled oil prices and helped trigger recessions in the United States. The Iraqi invasion of Kuwait in 1990 and the cutback on supply that tripled oil prices in 2000 both helped nudge the U.S. economy off the track.
Oil price shocks and price manipulation by OPEC from 1979 to 1991 cost the U.S. economy about $4 trillion, almost as much as we spent on the military, according to the Department of Energy's Office of Transportation Technologies.
Gulf War example
Arguments about war aside, the conventional wisdom is that a U.S. attack on Iraq will not trigger a global oil shortgage.
Rajeev Dhawan, director of the forecasting center at Georgia State, is among those who cite the Gulf War as precedent. Oil prices were already high, thanks to the Iraqi invasion of Kuwait. Outbreak of war sent prices shooting skyward to be followed quickly by the reverse as U.S. forces prevailed.
Each additional $1 per barrel translates to about 2.5 cents per gallon at the pump, economists say. Oil at $60 a barrel for any extended time could, therefore, mean gasoline selling for roughly 60 cents more per gallon than today.
The national average for regular gasoline is now about $1.66 per gallon, up from $1.13 a gallon a year ago, according to AAA.
While price boosts have been accompanied by allegations of gouging, most industry experts say price manipulation at the pump is limited. An Energy Department study in January showed a long-term match between global oil prices and what is -- eventually -- passed along to consumers. There is sometimes a lag, but the changes get to the pump within a few weeks, one way or another, the DOE found.
The consensus forecasts a repeat of the Gulf War pattern. Wall Street futures markets put the price of oil at about $25 per barrel by year's end.
So don't expect $2-a-gallon gas in Atlanta, Dhawan said. "I assume that it will be $60 a barrel for exactly 15 minutes."
War aside, current prices will likely continue for about three months, Dhawan said.
That will be a burden to the economy but no cause for renewed recession, he argued: Higher gas prices are more fodder for complaints than fatal to recovery, he said. "When the price of gas is $1.50, $2, $2.50 per gallon, we can all afford it, but we like to ... moan about it."
And thus far, the economy has only been "marginally" wounded by higher energy costs, said Richard DeKaser, chief economist for First National Corp.
Oil's economic value was greater in past downturns, he argued.
"If you look at real dollars, you cannot compare today's prices -- even at $36 a barrel -- to $40 in 1990 or even the mid-$30s in the 1970s," he said.
"Oil prices at this level are just nowhere near as harmful."
Proof of that is having oil prices up 87 percent in a year and the economy still expanding -- albeit slowly and somewhat sporadically. Producing each dollar of gross domestic product takes about half the amount of energy that was needed three decades ago.
But higher oil prices are still a tax that hits virtually the entire economy and transfers American wealth abroad, said Zandi of Economy.com. "There is probably nothing more pernicious to our economy than an increase in energy prices."