2007 energy outlook: costs up

Remember this? Motorists complaining at the pump as the price of gasoline rises. Airlines bumping up airfares to cover expensive jet fuel. And delivery services tacking on surcharges, reflecting a record price for a barrel of oil.

But it's not just a description of this past spring. It's also the forecast for next year, probably just when school lets out for the summer and motorists are starting to put more miles on the odometer.

"We could see close to $85 a barrel on crude next year," says Phil Flynn of Alaron Trading in Chicago.

If the forecast comes true, energy could be a dominant factor in the economic outlook for 2007 because, unlike this year, the potential increases would come when the economy is expected to be struggling. It would thus be the wrong time for the equivalent of a tax increase, which is how economists describe a spike in consumer energy costs. And it could catch the Federal Reserve in the middle of an energy-fueled jump in the inflation rate: Usually, the Fed tries to counter inflation by raising interest rates, but in a soft economy, it would rather cut interest rates.

"If we get a surge in energy prices next year, then the probability of a recession increases dramatically," says Dennis Jacobe, chief economist for the Gallup Organization in Washington. "It depends on how fast the rise takes place."

Yes, some energy analysts are beginning to think 2007 will be a case of déjà vu for consumers and business. In this scenario, prices start to ratchet up in the spring, peak sometime in the summer at a new record, and then fall back to lower levels later in the year.

Right now, the weather is an important factor, especially for the price of oil. Tuesday, oil prices hovered around $62 a barrel, some $18 a barrel below the high for the year, as relatively warm weather affected the Northeast. "We have had a relatively mild winter so far, some 20 percent to 30 percent above average [temperatures]," says John Felmy, chief economist at the American Petroleum Institute in Washington.

Last week, the National Weather Service said the warm weather in the Northeast will continue into the first week of January. But Mr. Felmy worries that a return to "normal" temperatures in January could prevent refiners from switching to gasoline production, because they would have to produce more home heating oil. "To get back a normal winter, it has to be colder than normal the rest of the winter," he frets.

It's not just the weather that's keeping a lid on prices. US economic growth is slowing – down to about 2 percent growth in the gross domestic product. The slower growth means crude-oil demand is slack – up only 0.2 percent on a year-to-date basis.

Sluggish demand has already forced OPEC to reduce production by as much as 600,000 barrels per day. OPEC's reduction also means the cartel has the ability to ramp up production to keep prices in check.

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