Sonny ---a good read on oil and where it is headed:
December 15, 1999
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The Price of Oil Has Doubled;
Why Is There No Recession?
By STEVE LIESMAN and JACOB M. SCHLESINGER
Staff Reporters of THE WALL STREET JOURNAL
Oil prices spiked to their highest level in nearly a decade last month. But when the consumer price index was released Tuesday, it was up a whispery 0.1%. How is this possible? After all, this is oil -- the stuff that helped fuel recessions in 1973, 1980 and 1990. Why aren't rising oil prices walloping the economy the way they used to?
Part of the answer can be found at LTV Corp. The Cleveland steelmaker is responding to this year's more than doubling of petroleum prices by flicking a switch. Using technology it installed over the past decade, it is shifting the fuel that fires its blast furnaces and boilers to natural gas from oil. Computer modeling lets LTV know when it's time to make the change.
Energy Secretary Warns U.S. May Act to Lower Oil Prices (Dec. 9)
Gains in Oil Prices May Not Fuel Speedy Rise in Capital Spending (Nov. 22)
Surge in Oil Prices Unlikely to Trigger Inflation in U.S. (Nov. 19)
Next, consider UAL Corp.'s United Airlines. The Chicago air carrier paid about the same for jet fuel in the third quarter as it did a year earlier, thanks to futures markets that let it lock in long-term prices. Good thing, too, since competition has hindered air carriers from pushing through broad-based fare increases.
Indeed, nationwide, the same forces that have propelled the U.S. economy through the 1990s -- new technology, greater productivity, deregulation and sophisticated financial markets -- are cushioning the blow from oil's jump to more than $25 a barrel from a February low of $11.37 a barrel.
'Startling Changes'
True, oil is the main reason consumer prices have risen at a 2.7% annual rate so far this year, up a full percentage point from 1998. But inflation still remains tame. In fact, last month's CPI increase was half the rate of October's and the lowest monthly rise since June.
That's because oil has become less relevant as the U.S. economy moves away from manufacturing and toward services. Fuel-gulping manufacturers accounted for only 17% of the economy in 1997, down from 22% in 1977. The decline's impact has been so pronounced that even Oil Minister Ali Naimi of Saudi Arabia, the world's biggest petroleum producer, lamented in a speech last week in Washington the "startling changes" that have reduced oil's importance to the world's industrialized economies.
Among them: U.S. oil expenditures have fallen to an estimated 3% of gross domestic product from a high of 8.5% in 1981, according to the U.S. Energy Information Administration. Suggesting that the growth of the Internet and the service sector has produced lasting changes in the economy, the U.S. in 1997 and 1998 posted its sharpest energy-efficiency gains in a decade, according to an analysis by the nonprofit Center for Energy and Climate Solutions. In both years, energy consumed per dollar of GDP fell by 4%, compared with the previous decade's average decline of less than 1% a year.
Given that trend, "businesses should be spending no more time anguishing over oil prices then they do about pork bellies," says Mark Mills, senior fellow at the Competitive Enterprise Institute, a Washington think tank.
Of course, some industries still feel like they are over a barrel when oil prices climb. Hedging can't delay the pain forever, so airlines and other transportation businesses eventually feel the pinch. In recent weeks, trucking companies have begun to demand higher rates, citing higher fuel costs. And this year's oil-driven rise in the CPI will boost labor costs next year, since many wage contracts are pegged to that index.
The real test may be yet to come. If industries stock up on fuel ahead of the New Year or a lengthy cold snap grips the Northeast, some analysts think oil prices could creep above $30 a barrel -- a level seen only briefly during the Gulf War. That scenario worries some economists. If prices reach that height and stay there, "economic activity slows, and the trade deficit worsens," says oil economist Phil Verleger of the Brattle Group, a consulting firm based in Cambridge, Mass. "It can be a prescription for a fairly serious and sharp recession."
So ingrained is the perceived impact of oil prices on the economy that some worry higher prices will create inflationary expectations all their own. But economists say that even at today's prices, oil and its derivatives are relatively cheap. Adjusted for inflation and excluding taxes, a gallon of gasoline is 10 cents cheaper today than it was in 1973, according to data from the American Petroleum Institute and the Energy Department.
Meanwhile, those industries that still rely heavily on oil have learned to squeeze more out of every drop. In 1981, for instance, jet fuel accounted for 29.7% of airlines' operating expenses, says the Air Transport Association. With new energy-saving technologies, such as two-engine planes with the same kick as the old three-engine versions, fuel now represents only 10% of the industry's costs.
The sport-utility vehicle craze has put more gas-hungry cars on the highways. But computer-controlled fuel injection and new transmission technologies have raised the overall efficiency of the nation's auto fleet by about 5% since 1990. The average American car was driven about 2,000 more miles last year than in 1973, but it used about 200 gallons less gasoline, the Transportation Department says.
For their part, energy-intensive manufacturers, such as LTV, have protected themselves from oil-price swings by diversifying their fuel sources. Natural gas, in particular, has become a popular alternative, because it is plentiful and relatively cheap. "Just 30 days ago, we were in the process of ramping down gas and ramping up oil," says Marty Suhoza, LTV's director of energy and metals purchasing. "Now we're doing just the opposite," he adds. "Our average fuel prices are fine."
When the first oil embargo hit in 1973, almost 17% of the nation's electricity was generated by burning more than 560 million barrels of oil. Today, with utilities deregulating and facing more competition, 3.2% of the nation's electricity is generated with the use of just 178 million barrels of oil. Coal, natural gas and nuclear power have taken up the slack.
In Silicon Valley, the heart of the New Economy, Santa Clara County added more than 150,000 jobs between 1994 and 1998 while area utilities relied almost exclusively on natural gas and renewable resources, such as hydroelectric power, to fill the new demand. California's environmental laws also resulted in a wholesale shift away from oil. The state's utilities, which burned 12 million barrels of oil in 1990, used just 103,000 barrels in 1998.
Absorbing the Jolt
On the financial-management front, the explosion over the past five years in the number of companies using financial markets to hedge their energy costs has left the U.S. better able to absorb an oil jolt.
United Parcel Service of America Inc. has hedged nearly all its oil purchases for next year, and as a result, "we've removed ourselves from the spot market," says spokesman Norman Black. Of course, if oil prices stay where they are for the next year or so, the shipping company ultimately will face higher costs. But, "this gives us the flexibility to build our whole budget for next year with a predictable number," Mr. Black says. "That allows us to better manage our cash flow."
The oil-price jump also is coming at a time of phenomenal cost-cutting, thanks in part to the magic of the Internet. Alaska Airlines, for example, now sells 8% of its tickets via its Web site, up from 3% a year ago. Its $7.5 million-a-year savings is about half its cost of higher fuel prices.
Pass-Throughs to Price-Downs
Even if oil-dependent companies can't completely offset higher fuel costs, the odds those pressures will translate into significant inflation are much lower today than they were 10 or 20 years ago. Through the 1980s and early 1990s, "we had pass-through economics," says Gary Williams, vice president for supply-chain management for Borg-Warner Automotive Inc.'s Indiana powertrain-systems division. Contracts had built-in price increases pegged to wholesale-prices rises. "Today, most contracts have fixed prices with price-downs" or built-in cuts, Mr. Williams says. So far, Borg-Warner's suppliers haven't sought higher prices to offset higher energy costs. "Companies are reluctant to be the first guy to ask for a price increase," he says.
In other industries, a capital-investment boom and competition have tempered oil's impact. With new factories slated to open next year in western Canada, an additional two billion pounds of polyethylene, a petrochemical used to make plastic bags, will be aimed at the U.S. market, a 10% increase, says Earl Simpson, a senior consultant at Pace Consultants Co. of Houston. "There's too much competition to hold prices up," he adds.
A More Aggressive Fed
Like corporate executives, economic policy makers also have absorbed painful lessons from earlier oil shocks, and appear better poised to handle a rerun. In retrospect, most economists believe that the Federal Reserve erred in the 1970s by keeping interest rates low to make sure oil-related production cuts didn't push up unemployment. But the easy money accentuated oil's inflationary impact, leading to double-digit price increases.
Today's Fed is much more aggressive about pre-empting inflation, and today's economy gives the central bank more breathing space. With the economy growing at well above a 3% annual clip and the unemployment rate at a 29-year low of 4.1%, the Fed can afford to fight inflation by cooling growth and pushing joblessness higher. Alternatively, the Fed has ample room to let prices rise a bit.
The politics of oil also have changed radically over the past two decades. The most powerful producers have learned that higher prices are risky, encouraging conservation efforts and new producers, who are harder to control. That may not be obvious from the current state of petro-politics. After all, the main reason oil prices have soared is that the Organization of Petroleum Exporting Countries, along with nonmembers Mexico and Norway, agreed to cut production, and compliance has been unexpectedly good. The group is hoping to make up for a glut of oil in 1996 and 1997 that sent prices tumbling as production increased and Asian demand fell.
With world inventories reduced, many expect OPEC to increase production again when the current agreement expires in March. At meetings last week with U.S. Energy Secretary Bill Richardson, Mr. Naimi of Saudi Arabia and Sheik Saud Nasser Al-Sabah assured Mr. Richardson their interest was in stable prices, not an oil crisis. That reflects an improvement in relations since 1973, when the U.S. learned in a terse cable that oil supplies to its Sixth Fleet in the Mediterranean and U.S. forces in Europe were being shut off, as the Arab nations launched their oil embargo.
Just One Crisis Away
As a result of all these factors, oil experts are betting on lower prices next year, even if there is another wintertime spike. While spot oil prices now trade at around $25 a barrel for January delivery, futures contracts for delivery one year from now sell for about $5 less per barrel.
Producers know there is much technology waiting in the wings to displace oil if they allow a sustained price spike. Hybrid automobiles, which use fuel cells and gasoline engines, as well as teleconferencing are just a crude crisis away from wider use, says Joseph Romm, a former assistant energy secretary and now director of the nonprofit Center for Energy and Climate Solutions.
That's why the oil industry has been undergoing its own revolution. Many oil companies are producing more natural gas. They are even joining with auto makers to develop alternative fuels and moving into the power-generation business. And, at Texaco Inc.'s Houston research facility, geologists are using a new computer-based technology to figure out the best place to drill for oil and the optimum method of extracting it.
Texaco earlier this year announced its largest discovery in 32 years, a massive field underneath about 5,000 feet of water off the coast of Nigeria. Without the greater certainty offered by the three-dimensional seismic data the new technology generates, companies could never afford to drill for crude a mile or more below the ocean's floor.
Assessing the seismic data, which once took 10 or 15 people, now takes one or two. Development planning times that took months or years now takes weeks. "The visualization technology will allow our crop yields to go up and reduce our risk," says Michael Zeitlin, a pioneer of the technology. "It's going to keep the cost of oil relatively flat and help us maintain oil prices at a level that is competitive with other energy so
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PS WHERE IS THE INFLATION THAT MR GREENSPAN IS LOOKING FOR ? |
