Tuesday, May 27, 2008

$130 Oil: Is That a Tipping Point?

Relentless rise in oil prices tests economy's resilience

After years of increases, some fear a tipping point has finally been reached.

By Peter G. Gosselin

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Only a few weeks ago, prominent policymakers and economists were cheerfully asserting that the U.S. economy would dodge recession and keep chugging forward despite a housing bust, a credit crunch and continuing job losses.

"The data are pretty clear that we are not in recession," said President Bush's chief economist, Edward Lazear. Treasury Secretary Henry M. Paulson Jr. declared "the worst is likely to be behind us" and confidently predicted that more than $100 billion in tax rebates would help create half a million new jobs by the end of the year.

But instead of clearing, the skies over the economy have ominously darkened in recent days. The chief reason is oil. And there are signs the nation may have reached an economic tipping point after years of shrugging off the petroleum problem.

"We may finally have crossed the line where the price of crude actually matters for most companies," said Peter Boockvar, equity strategist at New York financial firm Miller Tabak & Co. "The stock market has been in la-la land when it comes to oil, but they got a pretty good dose of reality the last few days."

The ill effects of the latest price hikes would not be so surprising if it were not for the fact that the nation's economy and financial markets remained blissfully unruffled by oil's upward march during most of the last five years. Until this week.

"The economic outlook has been taken hostage by the relentless surge in oil prices," said Robert V. DiClemente, chief U.S. economist at Citigroup in New York.

"We're seeing an inexorable increase, and it doesn't seem like anybody's in charge or can do anything about it," added Bank of America senior economist Peter E. Kretzmer.

Big, small firms take hits

Among the signs that the economy may finally be feeling the effect of rising oil prices was Ford Motor Co.'s announcement Thursday that it was abandoning any hope of making a profit this year or next now that sales of its gas-guzzling pickup trucks and Explorer sport utility vehicles have plunged.

And experts said that the other two U.S. automakers, General Motors Corp. and Chrysler, may be in even greater trouble.

Ford Chief Executive Alan Mulally said the industry had "reached a tipping point" where energy costs were fundamentally changing what kind of vehicles Americans buy.

Meantime, to cope with higher energy prices, American Airlines and United Airlines both raised ticket prices, and American announced plans to impose a new baggage-handling fee. But experts say the price hikes barely begin to make up for recent losses.

"The airline industry is devastated. It can't survive $130-a-barrel oil," said industry analyst Ray Neidl at Calyon Securities in New York.

Many analysts think that unless oil prices fall back to about $100 a barrel -- where they were as recently as April -- the industry will have to slash 20% of its routes, the equivalent of knocking two major airlines out of business.

Companies as far flung from oil as SanDisk Corp., the world's largest maker of the flash memory cards that go in such products as digital cameras and media players, said that sales were soft last month because rising oil prices were causing consumers to tighten their belts.

And it's not just big companies that are taking a hit. Ted Holcomb, owner of Los Alamitos, Calif.-based Fiesta de Carnival, said he had been staggered by rocketing prices for everything including the diesel and gas that fuel his trucks and the propane that vendors use to fry churros and grill taco fillings.

Fiesta de Carnival makes money organizing and staging about 25 events a year, many of them city-funded festivals and street fairs. The events feature games, live music, food, toys and rides, and are mostly attended by working-class Latino families who also are suffering from fuel-price shock.

The company is a good example of how rising oil prices can worm their way into every nook and cranny of the economy. Oil prices have doubled in the last year, with a barrel of crude rising $1.38 on Friday to $132.19 in New York trading.

"Attendance has been down 30% to 40%, and the people that do come have less to spend," Holcomb said. "A show usually has 15 rides and 50 to 60 kiosks. We use semi-trailer rigs and pickup trucks to move the equipment, so we're hit by gasoline and diesel prices. The bands want to be paid more because it's costing them a lot more to drive out to an event," he said.

Holcomb said that fuel costs have cut his profit. An event that used to rake in $50,000 now brings in only about $30,000. Meanwhile, the cost of putting on the show has climbed from $15,000 to $20,000.

"I've just never seen anything like this" during the 12 years his company has operated, Holcomb said.

Choosing alternatives

Across the country, Ken Coneff, a salesman at Fitzgerald Toyota in Gaithersburg, Md., said that until recently the auto dealership made its money selling pickup trucks while hybrids languished on the lot unsold.

Today, Fitzgerald is sold out of hybrids and has a long list on back order.

"Hybrid is scarce . . . like a bald eagle," Coneff said. Meanwhile, pickup trucks are piling up on the lot. "We're giving them away, in essence," he said.

Economists are generally skeptical about "tipping points" and claims of abrupt changes in economic direction.

"There aren't straws that break the economy's back," said Jim Glassman, senior economist at JPMorgan Chase in New York. Companies and consumers adjust only gradually to changes such as oil price hikes, he said.

And, in fact, there's evidence that people have been adjusting to higher gas, heating and electrical costs for some time now.

Energy Department figures show that oil and fuel consumption dropped by 2.3% over the last year. And the Transportation Department released data Friday showing that the number of highway miles traveled by Americans in March fell 4.3% from a year earlier, the steepest year-to-year drop since the government began keeping records during World War II.

But the price of oil has climbed so quickly and the most recent round of increases has struck at a moment of such vulnerability that many analysts are concerned that the economy is making a sharp swerve -- one that could set its direction for a long time to come.

"The economy sailed through $70 and $80 [a barrel] oil with almost no friction at all," veteran energy analyst Daniel Yergin said. "But there's a big difference between $80 and $120 or $130," he said. "Now we have an oil shock on top of a credit crunch, a housing slump and a slowdown."

Oil stifles stimulus plan

Analysts said that the latest increases were particularly disheartening because they knocked the wind out of what many had thought would provide the economy with a big, new boost: the arrival of $120 billion worth of tax rebate checks that Washington hopes will help rekindle growth by spurring consumption.

Chris Lafakis, an economist at Moody's Economy.com, a forecasting firm in West Chester, Pa., said that the oil price increases to date had absorbed the rebates that consumers will be receiving, and then some.

Even with no further increase in oil prices, the cost of gasoline will almost certainly rise from the $3.79 that it averaged nationally this week. That's because Americans drive more during the summer, pushing up demand and, with it, prices.

What that means, Lafakis said, is that if Americans drive as much as they did last summer, and oil prices remain stable, gas prices could hit $4.75 a gallon.

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