Being Street Smart October 8/04
by Sy Harding
October 8/04
The price of crude oil rose to a still higher record this week, breaking
above $53 a barrel. Spiking oil prices have never been good for the economy,
and as in 1973-74, have sometimes sent the U.S. economy spiraling down
into serious recessions. Yet this time surging oil prices, up a whopping
70% over the last 12 months, do not seem to be creating much concern.
Washington and Wall Street tell us that energy costs don’t account
for as much of U.S. Gross Domestic Product as in previous eras, and the
U.S. economy is strong enough to withstand the rising energy costs, particularly
since those rising oil prices are only temporary.
But are they temporary?
As recently as 1999, oil sold for as little as $10 a barrel. No one denied
that was too low. At that level oil producing countries were losing money,
and there was no incentive for oil companies anywhere to spend the money
to explore for and develop new oil fields. By the year 2000, oil prices
had gained ground to a more normal level between $15 and $20. When the
price rose further, to $22, OPEC, the consortium of major oil producing
countries, set a range for crude oil prices of $22 to $28, which they
agreed to control by increasing or decreasing the level of their oil production.
OPEC said it was satisfied with prices at the lower limit of the range
as being profitable for them, but did not want prices to rise above $28
for fear it would slow world economies (which would be bad for them as
demand for oil would decline).
But among other factors, OPEC had not foreseen the emergence of China
as a world economic power, and the resulting demand for oil that would
be created by China’s surging industrial growth, and pent-up demand
for automobiles by its huge population. China’s additional slice
of the oil pie, coupled with the recovery of other world economies from
the 2001 recession, quickly eliminated OPEC’s ability to control
rising oil prices by increasing production. As demand for oil increased,
OPEC and other oil producing countries increased their production to its
absolute limit. But oil prices continued to rise. Only Saudi Arabia is
thought to have any excess capacity at all, and that thought has come
into question recently as its promise that it would step up production
fractionally has not materialized.
World oil demand is growing at its fastest pace in 16 years, and increases
with every passing day. U.S, European, Asian, and Japanese economies are
growing again, and their main source of energy to fuel those economies
is oil. China is absolutely sucking in oil, importing 20% more this year
than last year.
Meanwhile, the supply side is not promising. Oil fields in the U.S. and
North Sea have matured and are producing less, while new discoveries contributed
only 6.8 billion barrels a year in 2001-2003, down from the average of
11.4 billion barrels annually over the previous five years. Iraqi oil
production, expected to come on line within months of the invasion, is
still running at half its production level prior to the war.
Granted, there is some fear factor built into oil prices. With oil production
running only 1% above demand, obviously a disruption to the supply from
terrorist actions, hurricanes, or what have you, could be significant.
So oil traders have built a speculative premium into oil prices that is
above the fundamental pricing created by the supply/demand situation.
But with world conditions becoming more volatile, not less, we can’t
expect that fear factor to come out of the price any time soon. And barring
a slowdown in world economies, it’s doubtful that the fundamental
price of oil will drop by a significant amount.
The problem is that the longer energy prices remain high, the more likely
they are to affect world economies, including that of the U.S. In fact,
Bank of Canada governor David Dodge warned this week that high oil prices
“could start to take a significant bite out of global growth soon”.
The first signs of that happening should show up in consumer spending,
which accounts for 65% of the U.S. economy.
Already, the effect of an extra 10 or 20 bucks coming out of their pockets
every week to gas up the family cars, and being warned that home heating
oil will cost 25% more this winter, probably had something to do with
retailers reporting this week that they had sluggish sales in the critical
back-to-school season this year. Meanwhile, the Conference Board reported
that consumer confidence fell again in September, the second consecutive
month of decline for that barometer. The Conference Board blames consumer
worries about jobs for the decrease in confidence.
I suspect it has as much to do with the dents that higher energy costs
are already putting in consumers’ spending plans.
Sy Harding is president of Asset Management Research Corp., publisher
of The Street Smart Report Online at
www.streetsmartreport.com and author of 1999’s Riding The Bear
– How To Prosper In the Coming Bear Market.