Falling US fuel prices ease fears of recession

Even with OPEC's decision this week to cut oil production, lower energy prices could persist – bringing a welcome boost to the economy.

The "oil dividend" is worldwide but comes at a sensitive time for the United States. By easing costs for heating homes, commuting, and running factories, lower energy prices reduce worries about a possible recession for the world's biggest economy.

Lower energy prices also promise to help fight inflation. According to a report Tuesday gasoline prices posted a record one-month plunge of 22.2 percent. And Wednesday, thanks in part to fuel costs, the Labor Department announced its broad index of consumer prices fell 0.5 percent in September.

"The lower energy prices certainly help," says John Silvia, chief economist at Wachovia Corp. in Charlotte, N.C. This doesn't assure a so-called soft landing for the economy, he says, but "it's enhancing the chances."

Crude oil still costs twice what it did three years ago, but the change over the past two months is significant. Motorists could soon be pumping gasoline at $2 a gallon, down from summer highs above $3.

Cheaper natural gas, meanwhile, promises to keep heating bills lower this winter, too.

Over the past two months price shifts in gasoline and natural gas have put some $90 billion, annualized, back in US consumers' pockets, according to research by economist Andrew Tilton at the investment firm Goldman, Sachs. That's sizable even in a $13 trillion economy.

By some estimates, the amount more than offsets the hit homeowners are taking from an upward jump in adjustable mortgage rates.

Several factors explain the softening of energy prices, from the end of the summer driving season to fewer hurricanes, which could affect drilling platforms in the Gulf of Mexico.

Demand cools for fossil fuels

Perhaps the biggest factor, however, is cooling demand for fossil fuels. That reflects some conservation by consumers, but it also stems from a slowing economy – the very problem that lower energy costs are now helping to alleviate.

"Demand continues to grow but at very low rates," says Mark Routt, a senior analyst at the consulting firm Energy Security Analysis Inc. of Wakefield, Mass.

America's output of goods and services, after expanding faster than 3 percent annually in 2004 and 2005, slipped to a 2.6 percent annualized rate in the second quarter, and third-quarter numbers are expected to be slower still.

Even as Chinese energy demand continues to soar, forecasters have pared back their outlook for the US, the biggest oil consumer.

The International Energy Agency last week predicted that world oil consumption will rise 1.2 percent this year and 1.7 percent next year. Those numbers shaved just a tenth of percentage point off prior forecasts, but such changes at the margins make a difference in energy prices.

Conservation also is playing a role. American consumption of gasoline typically grows by more than 1 percent a year, Mr. Routt notes. This year's growth will be less than 1 percent, not keeping pace with a population that surpassed the 300 million milestone this week.

This represents a natural response of the marketplace to higher-priced oil in 2004 and beyond. It prods consumers to use less and gives suppliers an incentive to expand production.

Mood changes, prices dip

All this has changed the mood of those who trade oil contracts on commodity markets. The price of oil has fallen from about $75 a barrel to $60 or lower in recent weeks.

Prices could still spike if supplies are disrupted in places like the Middle East, Iran, or Nigeria.

But the OPEC cartel is responding to the changed outlook. The Organization of Petroleum Exporting Countries meets Thursday in Qatar to formalize plans for a production cut of 1 million barrels a day.

It's not clear if the group will actually pull that much supply off world markets. Member nations aren't unanimous in their outlook, but backers of a cut don't want to let prices fall too far.

Routt sees oil prices staying relatively flat, but he wouldn't be surprised if gasoline dips below $2 as refiners shift to cheaper winter products.

Mr. Silvia's team of economists at Wachovia believe oil prices will remain around $60 a barrel early next year. He says gasoline is unlikely to fall to $2 a gallon from the current level of $2.23.

US economy adjusts

All this comes as the US economy is in a phase of adjustment. The Federal Reserve is trying to guide the economy into what economists call a soft landing, to restrain inflation without causing an outright economic slump.

It has raised interest rates incrementally since mid-2004 but is now sitting on the sidelines as the economy, and inflation, cools.

But soft landings aren't easy to achieve. The risk of recession has risen along with tighter monetary policy. To some economists, falling oil prices could be a symptom of that risk.

Merrill Lynch's David Rosenberg, in a recent report, notes oil prices fell 25 percent in the six months prior to the recession in 2001.

The price cut didn't prevent that recession, he says, because "the decline in crude was symptomatic of slower demand" in the economy.

Mixed expectations for the US economy

Today the housing market that was driven by low interest rates has weakened. A gauge of industrial production, announced Tuesday, fell 0.6 percent in September, a much steeper dive than analysts expected.

US employers created a tepid 51,000 jobs in September, according to the Labor Department's initial tally two weeks ago.

Still, other economists believe the US economy remains on solid footing. Silvia's forecast is for moderate growth, with the question of recession hinging on the housing market. For now, he says, lower energy prices are giving an important boost to consumers.

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