The Pro Shop - A Conversation With David Wyss
Over a Barrel “I don't think oil could cause a recession at the levels they're at now, but...if they get into that $40 to $50 range for a year, that could certainly cause [one].” — David Wyss By Scott Patterson March 6, 2003
MANY AMERICANS, IF asked for their opinion on the current state of "light crude," would probably reply with some disparaging references to Will Farrell's "Old School" and bemoan the pathetic state of the frat-house comedy, which has fallen into sorry times of late.
But ask a Wall Street economist about light crude, and you're more likely to get hand-wringing prognostications of double-dip recessions, global deflation and even — harkening back to the 1970s (which saw the birth of the frat-house comedy) — that dreaded word: stagflation.
Last week, the price of light crude oil touched $40 a barrel on the New York Mercantile Exchange, a level not seen since Iraq invaded Kuwait in 1990. Suffering from the shock of a strike in Venezuela and war jitters over the Middle East, oil prices have skyrocketed during the past few months, threatening to derail the shaky economic recovery and plunge the U.S. into its second recession in three years.
This is no laughing matter to Standard & Poor's Chief Economist David Wyss, who estimates that a double-dip recession could cause the S&P 500 to plunge 20% to the mid-600s. As Wyss points out, "we've got this huge cloud sitting in front of us called Iraq," and everything depends on what happens there. If the war is quick and crude production in the Middle East is left relatively stable, then the price of oil will drop and a recession will probably be averted. But if things don't go to plan, all bets are off.
SmartMoney.com asked Wyss, 58 years old, for his opinion on the economic fallout from high oil prices, whether the Energy Department should open up the Strategic Petroleum Reserve and who stands to benefit from the rising cost of energy in today's market.
SmartMoney.com: What are the odds of high crude-oil prices leading to a recession?
David Wyss: It depends on how high they go and how long they stay high, which depends mostly on what happens in Iraq. I'd have to say the odds are 25% to 30%. I don't think oil could cause a recession at the levels they're at now, but they're getting close to that level, and if they get into that $40 to $50 range for a year, that could certainly cause a recession. If it gets into the $60 range, it wouldn't have to stay that high for as long. It's a tradeoff between price and length. In today's prices, we hit $75 in 1979 during the Iranian hostage crises, and it stayed above $40 in today's dollars for over five years from 1979 to 1985, so high prices can be sustainable for a long time.
SM: How would a double-dip recession impact the S&P 500?
DW: Not good [laughs]. I think we would find some new lows. We're already down a lot, of course. My guess is that we'd probably get a correction down into the mid-600s. Any recession should last as long as oil prices stay high. If oil prices start to come down, we'll start to see the stock market recover. It would take the economy a while to turn around, but the market's normally a leading indicator. The market will start to turn up as soon as it sees the light at the end of the tunnel.
SM: Which industries will get hurt the most by the high cost of oil, and who will benefit?
DW: Well, start with the usual suspects. Transportation gets hit, especially airlines. Tourism drops off. Obviously areas like trucking are going to have to try to pass through higher costs. Also utilities, although they don't burn as much oil anymore. The refining businesses take a hit. Although with the refiners, if you have an integrated producer, they're going to make up enough on the crude to offset what they'll lose on refining. It's the pure refiners that are in trouble. Also car companies, because when oil prices go up people don't want to buy those huge SUVs anymore. In the last month or two we've seen a huge drop-off in SUV sales, and part of that I think is people are realizing how much it costs to fill up the tank on a Chevy Suburban. The crude producers will benefit, of course. If the prices stay high long enough, the oil-service providers will see a big upside, as well as the natural-gas producers, and probably some of the alternative-energy producers.
SM: Do you think high oil prices could cause deflation, as Morgan Stanley Chief Economist Stephen Roach has argued?
DW: I tend to disagree with that. I was around in the 1970s, and believe me, the high price of oil didn't cause deflation back then, and I'm not sure why it would now. High oil prices will slow the economy, they can cause recession, but to call that deflation seems to be a misuse of the term. If energy costs go up for manufacturers, they have to raise the price of their products, or else they lose money. That's the standard argument. That's not deflation by any normal use of the term. I think what [Roach] is doing is mixing up deflation and recession. Yes, high energy prices can cause a period of stagnation, but I'm much more worried about this causing a repeat of the stagflation [a combination of high inflation and weak growth] of the '70s than a Japanese-style deflation.
SM: Many analysts are blaming war fears for the high cost of oil, but what about the strike in Venezuela? Hasn't that had a big impact as well?
DW: I actually think that's more of a factor than war fears. We're losing about two- to two-and-a-half-million barrels a day in Venezuelan production. That's more than the total Iraqi production. Without the situation in the Middle East, of course, we'd be seeing high prices, but probably not this high, and it wouldn't last as long. And we might have been able to put more pressure on Venezuela if we weren't so worried about Iraq.
SM: In 1991, after the Gulf War, oil prices dropped precipitously. But some economists are arguing that, since oil inventories aren't as high as they were during the Gulf War, prices will remain inflated after a war because there won't be sufficient supply to push the cost of oil down. What do you think?
DW: I'm not sure that's true. I don't think we've counted all the reserves. I remember that people made the same argument back in 1991. There's always a tendency to look back at the last two points and draw a straight line between them and call it a long-term trend, and I think we're getting that in the oil market. There seems to be a long-term stability for oil prices, corrected for inflation, in a $20 to $30 range. If you go back to pre-OPEC days, prices are running around $20 a barrel at today's prices. So except for that period from 1979 to 1985, it's been in that range since about 1960. So I think oil prices will drop to the extent that there is going to be a knee-jerk rise, which will then go down after the war ends. But how quickly oil prices come back down depends mostly on how much damage gets done to the oil fields during the war and how long it takes to bring them back online. It depends on how the war goes. Absent damage to the oil fields, I don't think there's any reason to believe that oil prices won't go back down. I don't think they'll go down to $18, but I do think they'll go back down to the high $20s.
SM: Energy Secretary Spencer Abraham has resisted calls to open up the Strategic Petroleum Reverse so far. Do you think the Energy Department should release some of the reserves?
DW: No, because what happens if there's a war and we really do get cut off? Maybe the high prices now are hurting the economy, but if you don't have that reserve ready when we go into war, what do we do? Releasing a minimal amount won't do anything. You've got to supply significant added oil to the market, and if you do that you deplete the reserves that have to be there to fight a war. It's true that today's prices are high enough to cause some damage to the economy. Roughly what we've seen today is about $50 billion off consumer purchasing power from the rising oil prices over the last six months or so. Generally speaking, $10 on oil adds a little over half a point to inflation and takes about three-tenths of a point off of gross domestic product.
SM: Will OPEC offset the high prices by expanding production during the war?
DW: It'll try, but whether OPEC can do it or not is the question. If everything goes to plan, it wouldn't have to produce that much more extra, because we don't get that much from Iraq. It's less than we're losing in Venezuela because of the strike. So if there's no disruption of other production, then it's not a big deal. Be there's probably going to be a lot of Kuwaiti production shut down. And there's always the risk of not just disruption to the fields, but disruption of the oil flow through the Straits of Hormuz as a result of terrorist activity or Iraqi military action. They could drop bombs on a couple of tankers going to the Straits, or terrorists could run a speedboat up to one and set off a bomb, or even fire a shoulder-fired missile from the shore. And if you have terrorism targeted against major refineries, against oil shipment facilities in the Middle East, it could have a major impact.