31-10-04

Anyone old enough to remember the 1970s and early 1980s -- gas lines around the block, rampaging inflation, decades-old factories shutting their doors -- can't help but look at the soaring cost of oil with fear and trembling.
Though crude oil prices seem to have topped out, they've risen 78 % over the past year - 23 % in just the past two months. Sooner or later, common sense would tell us, those high prices will work their way like tapeworms through the rest of the US economy.

Inflation, so low for so long that few people think much about it any more, will return with a snarl. Spooked consumers will cut back on spending, retailers will slash their merchandise orders, and manufacturers will lay off even more workers. The recovery, still tentative more than three years in, will shudder and seize up like an oil-dry engine.
Common sense is almost surely wrong. The US economy is far less sensitive to spikes -- or drops -- in oil prices than two decades ago, economists say. Expensive oil likely will slow economic growth this year and next, but not enough to send the nation back into recession.
"Oil is not as large a share of the economy as it used to be," said Mark Spiegel, vice president of international research at the Federal Reserve Bank of San Francisco.

Recent government readings of the economy support that assessment. The US Commerce Department reported that the economy grew at a 3.7 % annual rate in the third quarter -- slower than most economists had forecast, but faster than in the second quarter.
Earlier, the Federal Reserve's "beige book" survey concluded that, although "higher energy costs were constraining consumer and business spending," the overall economy still grew in September and early October. While the impact of higher prices is felt keenly by lower-income people and by businesses that use a lot of petroleum -- think truckers, airlines and plastics-makers -- Spiegel and other economy-watchers don't see it spreading much beyond them.

And those high gasoline prices? So far, at least, they haven't stopped many people from driving, nor are people scrimping on other purchases. According to the Commerce Department, retail sales (excluding autos) rose 0.6 % in September -- twice the rate analysts had predicted.
"It's important to recognize that, unlike the oil shocks of the 1970s and 1980s, oil is still available," said Ed Yardeni, chief investment strategist for Oak Associates in Akron, Ohio. "Nobody's reported any shortages of heating oil yet, and you can still go down to the corner gas station and fill your tank."

Of course, it'll still cost you. The average price of regular gas in Seattle was $ 2.068 a gallon -- 7.7 cents higher than two months ago. But gas is still far below the $ 2.307 average it hit this past May.
"The reality is, we haven't seen $ 50 a barrel [oil prices] reflected in the price of gasoline," Yardeni said. "We saw $ 35 and $ 40 a barrel [prices], but we haven't seen $ 50. I'm a bit puzzled by it myself."

For businesses like Edmonds-based Innovative Vacuum Services (Innovac for short), $ 2-plus is plenty high enough. The company, 50 years old this year, uses large truck-mounted vacuums to clean everything from home heating ducts to the Grand Coulee Dam's powerhouses.
But with their engines running eight or nine hours a day to power the air compressors, Innovac's trucks gulp fuel. The largest units can burn $ 250 worth of gasoline or diesel in a working day, company president Chuck Mott said.

Mott expects to pay about $ 111,500 this year for fuel, a third more than Innovac spent last year -- even though he's told his staff to buy all their gasoline at Costco to save a few pennies per gallon. With the company looking at a third straight year of losses, Mott earlier reluctantly raised his rates -- 3 % to 20 %, depending on the service.
"We just said, 'Folks, we can't do it for less. We're not a charity,' " Mott said. "The trucks are what they are."

Innovac is hardly alone:
-- Seattle-based Alaska Air Group spent $ 384.8 mm on airplane fuel in the first nine months of this year, 42 % more than the same period in 2003. Fuel costs were a big reason the airline's operating loss in the period deepened to $ 13.9 mm, from $ 1.3 mm a year earlier.
-- United Parcel Service's fuel bill in the first half of the year was $ 620 mm, 20.9 % higher than the year-earlier period. The impact was partly offset by higher fuel surcharges for air-delivery packages.

Such fuel-intensive businesses are hit the hardest by oil-price hikes. In a recent survey of corporate financial executives by Baruch College, 36 % of manufacturers said their profits were being hurt by high oil prices. But manufacturers made up less than a third of the Baruch sample; among all the executives, only 19 % reported significantly lower profits; fully two-thirds said their companies' earnings weren't tied to the price of oil in any significant way.
"In the '70s, an increase in the price of oil created bottlenecks in a lot of very important sectors of the economy," the Fed's Spiegel said. "With the growth of the service economy, that's not so much a factor."

Spikes in the price of oil have preceded nine of the 10 US recessions since World War II. But several factors have combined to weaken that linkage: the rise of services, health-care and technology industries; advances in energy conservation; and fuel substitution (natural gas instead of oil in power plants, for example). Those changes also allow the United States to get more economic "mileage" from each barrel of oil.
According to the federal Energy Information Administration, the US will consume about 7.5 bn barrels of oil this year. (A barrel of crude equals 42 gallons.) That's 27.4 % more than in 1981, the peak year for oil prices on an inflation-adjusted basis.
Back then, the US economy produced $ 974 in goods and services (in today's dollars) for each barrel of oil consumed, an analysis shows. Today, the economy produces $ 1,580 in goods and services per barrel. Viewed another way, in 1981 the nation's spending on oil accounted for 6.6 % of all economic activity; today, it accounts for just 2.2 %.

High oil prices are still a drag on the economy. But it's more a light tapping on the brakes: Although Fed Chairman Alan Greenspan said recently that oil has slowed US growth this year by about 0.75 %, the Fed still expects the economy to grow at an annual rate of 3.9 % in the current fourth quarter.
Chang Mook Sohn, Washington state's chief economic forecaster, said that for every $ 10-a-barrel increase in the price of oil, $ 100 mm is sliced off state residents' disposable income. That sounds like a lot, until you consider that Washingtonians' total disposable income is around $ 160 bn. Still, Sohn said, "$ 100 mm is $ 100 mm, and it is reasonable to expect some negative impacts on consumption." And people at the lower end of the income scale probably will be hit the hardest.

At least in the short run, gasoline and other energy use is inelastic -- meaning it doesn't change much in responseto price increases (or decreases). That means higher pump prices act like an extra tax, reducing people's disposable income; people with less disposable income to start with are most likely to cut back their spending elsewhere.
Recent data on retail sales and consumer sentiment paint a rather blurry picture:
-- Figures from the Washington Department of Revenue show taxable sales in the first seven months of 2004 were up 5.8 % over the same period last year. That includes the period of highest gasoline prices, but because of a lag in reporting not the most recent oil price spike.
-- The University of Michigan's consumer confidence index fell to 91.7 in October, on the heels of a weaker-than-expected 94.2 reading in September.
-- A survey of 71 chain stores by the International Council of Shopping Centres found that same-store sales (sales at stores open at least a year) were up just 2.4 % in September, compared to 5.9 % in September 2003.

Some retailers and consumer-products companies -- Wal-Mart, Hasbro and Mattel among them -- have blamed their lacklustre sales on higher gasoline prices. But other retailers have thrived in the same environment: Issaquah-based Costco, for example, said same-store sales were up 10 % in fiscal 2004, and profits were up 24 %.
Perhaps more tellingly, same-store sales were up 8 % in the five-week period that ended Oct. 3 -- as oil prices approached and then breached the $ 50-a-barrel level.

Greenspan and other Fed officials have expressed concern that persistently high oil prices could trigger higher inflation. A survey of Northwest business owners conducted by consulting firm The Rainier Group found that two-thirds were planning to raise prices within the next six months -- even though just 14 % said higher fuel prices would "significantly" affect their operations, and 62 % said any impact would be minimal.
But according to the Commerce Department, an inflation gauge tied to gross domestic product rose at a 1.3 % annual rate in the third quarter, after gaining 3.2 % in the second quarter -- suggesting that so far at least, higher energy prices haven't spread through the broader economy.

Should oil rise even higher -- say, $ 70 or $ 80 a barrel, levels that on an inflation-adjusted basis would exceed those of 1981 -- then "absolutely it might change the direction of the entire economy," Sohn said.
But, Oak Associates' Yardeni said, competitive pressures have limited the ability of most companies to pass on price increases, while the decline of labour unions and generalized economic uncertainty make it less likely workers get pay raises.

In the Baruch College survey, only 17.7 % of companies said they had passed some or all of their additional energy costs to their customers; a third absorbed the cost themselves, while the rest reported no impact.
"This has been a very interesting stress test of the American economy, and the global economy," Yardeni said. "And so far, we're passing it very well."

Source: Seattle Times