The price of crude oil is poised to cross the $100 a barrel (Rs3,930) threshold, raising the prospect that the burden on consumers and businesses could be the final straw to tip the US economy into a recession.
How the oil market got to this historic milestone—with prices nearly doubling from their 2007 low of $50.48 and more than tripling since 2003—is a twisting tale of hurricanes, speculators, refinery constraints, and geopolitical jitters. Many fear the fallout, long cushioned by robust growth, soon may be felt in everything from rising petrol and heating bills to higher air fares to reduced corporate earnings.
Macro view: A 26 September 2005 picture of a petrochemical facility in the aftermath of Hurricane Rita, in Port Arthur, Texas. Oil prices jumped to a new trading record above $98 a barrel on Wednesday.
“This is definitely a major threat to the economy,” said Brian Bethune, economist for Global Insight, a research firm in Waltham, Massachusetts, who warned that sustained per-barrel oil prices in triple digits could shave as much as 0.5% off an already slowing gross domestic product (GDP) next year. “We’re getting down to a critical stall speed.”
That could mean consumers scaling back on holiday shopping to offset soaring prices at petrol pumps, or businesses hiring fewer workers and passing higher energy prices on to customers.
Bad weather, which drives up energy demands, or international tensions that put oil supplies in jeopardy could send prices even higher and make a downturn even more likely, said Jim Burkhard, managing director of Cambridge Energy Research Associates. “If we get a cold winter, we could see $110 a barrel,” Burkhard suggested. “In our view, if prices stayed at that level for six months to a year, that would contribute to a significant economic slowdown.”
Analysts said it was only a matter of time before the crude price hits $100 a barrel.
“This ship will right itself at some point,” said Sarah Emerson, managing director at Wakefield consulting firm Energy Security Analysis, who said the severity of the economic impact will depend on the duration of the run-up. “But in the meantime we’ll be dealing with very high prices.”
Petrol prices, which have lagged crude oil increases in recent weeks, are expected to move up as the holiday travel season approaches.
Oil’s spurt toward triple digits comes as the Federal Reserve Board struggles to stimulate the economy through interest rate cuts to avoid a recession, defined as a significant decline in the gross domestic product and other economic measures lasting more than a few months. But the economy faces multiple challenges which, in addition to surging oil prices, include a weakening dollar and problems in the housing and subprime mortgage markets that have taken a toll on low-income homeowners and Wall Street financial firms.
Breaking the $100 a barrel barrier may be “an inevitable rite of passage”, as Bethune put it, at a time when developing countries such as China and India are importing record usage of oil to feed their rapid industrial expansions. But this year’s spike in prices, the largest in percentage terms since they quadrupled in the early 1970s, was driven by a mix of factors more complex than simple supply and demand.
Oil refineries, squeezed by narrower profit margins, have been reducing capacity worldwide even as demand has grown, leaving the supply chain much tighter than it has been in the past. “There’s very little buffer in the system,” Emerson said. “We’re in a situation where we’re running refineries harder and we’ve outgrown our capacity.”
The situation was aggravated last spring when refineries on the Gulf Coast were closed for maintenance delayed by their efforts to recover from Hurricane Katrina. And aware that traders are sensitive to any global event that threatens the flow of oil, from the standoff over Iran’s nuclear ambitions to the sabre-rattling of Venezuela president Hugo Chavez, speculators have contributed to the price run-up by snapping up oil futures, essentially betting that prices will rise. Hitting $98.37 put the crude oil price in sight of $100 a barrel. Adjusted for inflation, that level remains slightly below the peak attained in 1980, which would be equivalent to $101.70 on Thursday.
The fact that the US economy has withstood the impact of rising prices so far “highlights in dramatic fashion how different the oil market and the whole world economy is today compared to the last two decades,” said Burkhard.
Because of production efficiencies and a more diverse global economy that includes India and China, Burkhard said it takes only six-tenths of a barrel of oil to produce $1,000 in real economic output today, versus nine-tenths of a barrel in 1980. “We simply need less oil to produce the same economic output today,” he said.
A. Denny Ellerman, a senior lecturer on energy economics at the Massachusetts Institute of Technology’s Sloan School of Management, said he anticipates oil prices will retreat from the $100 level as production increases, demand drops and capacity is expanded, following the same cyclical pattern that sent prices tumbling after oil shocks in the 1980s.
Others say the oil price trajectory will depend on a range of factors, including weather, changing demand in global markets, and developments in the Persian Gulf.
“I don’t know if $100 is a target we bounce off of or a target we sit on for a while,” Emerson said.
©2007/THE BOSTON GLOBE