$50-plus oil drags on economy

Record prices boost cost of heating oil, unnerve stock markets, and clip GDP growth.

By , Staff writer of The Christian Science Monitor

Oil prices above $50 a barrel - and rising - are now starting to adversely affect the economy and consumers in ways that had not been happening only a few months ago.

• Home heating this winter is now expected to cost consumers an extra 50 cents a gallon even before the first snowflakes hit the ground. This means those who heat their homes with fuel oil or natural gas may pay $500 more this winter to stay warm.

• Financial markets are starting to focus on the effect of high energy prices on earnings. Thursday, world stock markets started off lower as oil prices jumped above $53 a barrel early in the day - another record (not adjusted for inflation).

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• Economists are lowering their growth forecasts for next year as they factor in the surge in oil prices. Every one-cent rise in the price of crude, which is up 60 percent so far this year, costs the US economy $3 billion.

A run of bad news continues to roil the oil markets. On Wednesday, for example, there were reports that the amount of oil and natural gas shipped out of the Gulf of Mexico shrank again as work crews examined the affects of Hurricane Ivan. Oil production in the region is off by 478,000 barrels per day, or about 28 percent daily production.

"I've seen photos of some of the rigs and the damage is just stunning," says John Felmy, chief economist at the American Petroleum Institute (API) in Washington. "So now the companies are examining for damage below the waterline and on the pipelines, so it looks like a bit of a setback."

Problems in Gulf of Mexico

Mr. Felmy says problems also continue on the refining side, where some capacity is still shut down because of hurricane damage. Refiners are now running at about 90 percent of capacity compared to 95 percent before the storms. This is one reason home heating oil has continued to rise in price.

"We can't afford to lose one drop of production because supply and demand are so closely balanced," says Mike Fitzpatrick an oil trader at FIMAT USA, a trading firm. "Every event seems to have a disproportionate response as far as price is concerned."

Thursday, for example, another setback occurred when Shell Oil curtailed its exports of about 1 million barrels of oil per day in Nigeria because of a surprise strike.

While no one knows for sure how high prices might go in this mercurial market, some analysts now think they will hit $55 a barrel before dropping down to $50. One thing seems certain, though: "It's still going to be expensive," says Mr. Fitzpatrick.

Oil traders are also starting to watch the weather. A forecasting service, Planalytics, is calling for a major cold snap to hit the Midwest and Northeast by the middle of next week.

"This could result in a November-like feel to consumers, including the potential for snow flurries in some of the major northern markets like Chicago, Detroit, Minneapolis, and Toronto," says the service.

The result, higher heating oil prices, will hit the economy during the crucial fourth quarter when consumers normally help give the economy a push into the next year. Already, retail analysts think the higher cost of heating homes is going to cut into consumer spending at the holidays.

"The bottom line is that because they are spending more to stay warm, they will have less discretionary income," says Lynn Franco, director of the Conference Board's Consumer Research Center in New York.

Even before the price of oil started rising sharply, early estimates for the holiday season were modest. The National Retail Federation is predicting a 4.5 percent increase in holiday buying. "People will persevere," says Scott Krugman, a spokesman, but he adds: "Oil prices stink."

Investors are none too happy about oil prices as well. "The stock market is trying as hard as it can to shrug off the rising price of oil because the labor market appears to be improving," says Anthony Chan, managing director and economist at JP Morgan Fleming Asset Management in Columbus, Ohio. "But at the same time, it's a gnawing problem."

How much of a problem is still not clear. Most economists expect the high price of oil (although it's still not as high as the 1970s on an inflation-adjusted basis) to lop off between half and three-quarters of a percent from the nation's Gross Domestic Product next year.

Slower growth

In fact, the Business Council, a trade group of chief executive officers, Thursday released a poll of 50 CEOs who cited energy, as well as the threat of terrorism, as some of the reasons they expect the US economy to grow by under 2 percent next year.

This is the most pessimistic forecast yet. Most economists anticipate 3.5 to 4 percent growth in 2005.

"The big question is when do high oil prices push us into a recession," says Mr. Chan. "We don't know yet. There is no target price, but as you move to $60 a barrel, it gets very, very dicey and even the Federal Reserve will begin to question what it's doing."

The high price of oil has already cut into the earnings of many companies, such as retailers, airlines, aluminum smelters, and truckers.

Still, rising energy costs are not affecting everyone: the high-technology sector, hotels, and biotechnology companies are reporting strong third-quarter earnings gains.

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