Economic risks of high oil prices

Energy is credited as a factor behind slower than expected second-quarter GDP. Most experts see prices staying high.

Record-high oil prices signal new danger to the economy, as rising costs ripple into everything from floral deliveries to the production of plastic toys and orange juice.

Crude-oil costs of $50 per barrel suddenly don't seem far-fetched, not in a week that has seen costs top $44 for the first time in 21 years of government reporting.

Experts differ on how much the recent spike is affecting economic growth - and whether the current US expansion is now at risk. But at the very least, consumers and businesses face a new headwind.

Already, rising energy costs have been tagged as a factor behind a slackening of consumer spending. Growth in the nation's gross domestic product (GDP) expanded at a slower-than-expected 3 percent annual pace from April to June, down from a 4.5 percent rate for the year's first quarter.

Today's economy is in some ways insulated from the oil factor. Equipment in factories and appliances in homes have become more energy efficient. Commerce in a service economy happens increasingly over fiber-optic cables rather than roads.

But oil still matters. Consider that each recession in recent decades was preceded by a rise in oil prices. Today's spike hits hardest for airlines, truckers, and people who drive a lot. But few sectors of the economy are wholly unaffected.

"It's a very tight market. There's just no excess capacity out there. And there is a lot of uncertainty," says Mark Baxter, director of Southern Methodist University's Maguire Energy Institute in Dallas. "And going into the election, naturally President Bush doesn't want to see [slower economic growth]. But the problem is, there is no short-term fix before November."

Prices remain far from their historic peaks - such as the early 1980s - when adjusted for inflation. But costs have jumped a long way from the late-1990s era of gasoline below $1 a gallon.

Demand and supplies

Most economists expect prices to stay high in the near future, as demand from expanding economies, like China, devours a stretched supply.

OPEC countries, particularly top exporter Saudi Arabia, have some room to boost production, says Dave Costello, an economist at the US Energy Information Agency. But he says the Organization of Petroleum Exporting Countries is getting close to capacity. So extra supplies are not expected to help deflate the market, at least for the next year, he says.

This Wednesday oil prices reached 21-year record highs at $44.34 in overnight trade. That's the highest price since oil futures were launched on the New York Mercantile Exchange in 1983. Oil prices have risen by more than a third since the end of 2003.

Because the market is so tight, "any disruption, however minor, causes prices to spike," says Mr. Baxter. There's the continuing violence in Iraq, including fresh pipeline sabotage this week, concerns over other terrorist activities in the Gulf region and elsewhere, an Aug. 15 referendum on Venezuelan President Hugo Chavez, and labor unrest in Nigeria. The spiked prices on Wednesday were due in large part to instability in Russia, where the Kremlin had demanded billions of dollars in taxes for the year 2000 from Yukos, the country's largest oil company.

Consumers - and consumer spending - has already been affected. A family with two cars, for example, that logs 22,000 miles a year at an average of 20 miles a gallon, will spend an additional $550 a year if gas prices go up 50 cents, Mr. Costello says.

Some analysts say higher gasoline prices have already affected annual economic growth - by perhaps 0.8 percentage points.

"In terms of the little guy, already fuel prices have affected the airlines, trucking companies, and orange-juice manufacturers, for instance - and that is passed on to the consumer," says Amy Jaffe, the associate director of the energy program at Rice University in Houston. To be sure, high oil prices affect the economy much less now than historically because the economy is much more service-oriented, she says.

For all the new uncertainty about the economic recovery, Costello says he expects "pretty much normal" GDP growth next year of 3.2 percent, down from 4.6 percent this year.

John Felmy, chief economist for the American Petroleum Institute in Washington, disagrees. "The combination of high petroleum and high natural gas prices is a real drag on the economy," he says. "Many economists speculate that a large share of [slower GDP growth expected for next year] is due to ... energy prices."

Nearing a top?

One positive sign: prices retreated a bit late Wednesday. "That is a big deal, because I really think we are looking at the top here," says Sarah Emerson of Energy Security Analysis in Wakefield, Mass. "I think this is the worst of the crisis."

Meanwhile, demand is not expected to slow down.

Ms. Jaffe says gasoline price spikes usually don't affect the economy for at least two years. She does, however, believe that energy will be part of the presidential debate. "We still don't have an energy policy. And while there is a lot of blame to go around for that, the fact of the matter is Bush was president."

Mr. Felmy agrees on the need for conservation steps, new infrastructure, and other energy policies. "We have problems we need to address," he says. "Without those adjustments, it's like we're in the movie Groundhog Day."

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