Oil Prices: How Big a
Threat?
(Hint: Watch the $40 Mark)
By ERIN SCHULTE
THE WALL STREET JOURNAL ONLINE
With one eye on Iraq and the memory of Kuwait's
fiery oil wells still burning bright in their memories,
some economists say the U.S. is set up for an energy
crisis of historic proportions.
Economists are watching crude-oil prices -- which
recently topped $37 a barrel, their highest level in
more than two years -- with much hand-wringing.
"Whenever we've seen oil prices approach $40 a barrel and stay there a couple of months, we have had a
very high risk of a new recession. The $37 is definitely raising eyebrows," says Lakshman Achuthan,
managing director of the Economic Cycle Research Institute in New York. "It's not so much the number,
it's whether it persists at those levels. If oil approaches $40 and stays there for two months, the risk of GDP
being negative is high."
That overused word of late, "uncertainty," permeates talk of how action in the Middle East may affect oil
supply and prices. During the Gulf War, Saddam Hussein's retreating troops set the country's wells ablaze,
making more than one billion barrels of oil go poof.
Even Americans who aren't glued to CNN as events unfold in Iraq can't escape geopolitical issues. It's
common knowledge that higher oil prices act like an additional tax on consumer spending -- put simply,
when that whole $20 bill goes to fill 'er up, there's nothing left over to spend on beef jerky or a six pack of
Schlitz at the Kwik-E-Mart. Gas prices are currently at $1.66 and rising, according to the U.S. Energy
Information Administration.
Increased heating-oil prices also take a bite out of household
budgets, and in the densely populated Northeast, this winter
has been bone-chilling (in case you're a stickler for numbers,
January here in the New York area was 32% colder than last
year, the EIA says).
None of this is good news considering that the American economy has relied entirely on the consumer to
keep it limping along the past year; businesses are still mostly in bunker mode, awaiting better earnings
visibility. Should consumer dollars suddenly start to dry up, it would be dire for the economy.
Meanwhile, a nasty confluence of events has some who watch oil markets predicting supply disruptions
much like those in the 1970s.
Besides the expected war in Iraq, a strike in Venezuela -- the world's fifth-largest exporter of oil -- has
capped supply. Economists point out that U.S. dependency on foreign oil is near an all-time high, and
inventories are near record lows.
According to Dr. A.F. Alhajji, an assistant professor of economics at Ohio Northern University with a Ph.D.
in petroleum economics, U.S. dependence on oil imports is currently about 53%; thirty years ago, only 35%
of oil used here was imported.
In addition, there's just not as much out there.
The current world excess petroleum capacity is the lowest in thirty years, excluding 1991, when Iraq and
Kuwaiti capacity were taken off the market because of the Gulf War, says Dr. Alhajji, who is also a
contributing editor for World Oil magazine.
He compares the current situation to 1979, when the Iranian revolution took 5.6 million barrels of oil off the
market every day for six months (the largest supply disruption ever), and 1973, when the Arab-Israeli War
diverted more than four million barrels a day. The Gulf War also diverted more than four million barrels a
day, according to the International Energy Agency.
"The probability of getting into an energy crisis has never been higher," says Dr. Alhajji. "Both those years
were followed by recessions, but those years the energy crisis happened after periods of economic growth.
This is the first time we are having an energy crisis when the economy is down. No one in the government
or private sector knows what to do."
After the Gulf War, oil prices dropped sharply. But some worry that the possibly different (read: messier)
nature of a new war in Iraq could keep oil prices inflated.
"The problem I have with Iraq is not only taking the Iraqi production off the world supply but all the other
repercussions that could happen -- will this escalate to other Persian Gulf states? That's a worse-case
scenario," says Mark Baxter, director of the Maguire Energy Institute at the Cox School of Business at
Southern Methodist University and a 28-year veteran of the oil industry.
About 20% of the world's and oil supply comes from the Persian Gulf, and Mr. Baxter says the U.S. could
be cut off from more than just Iraq's supply. "On the richter scale of disruption, this has the possibility of
being the largest ever recorded," he says.
Meanwhile, the U.S.'s economic picture is much different this time around than it was during previous
supply disruptions. Unlike the two crises in the 1970s, we are stuck in a period of slow economic growth;
should things pick up, oil prices could remain stubbornly high.
"If the war is quick, you have a much stronger economy at year's end. You'll have stronger demand [for
oil], and it's unlikely to fall that much," says ECRI's Mr. Achuthan. "But if the war drags out, you have
geopolitical issues keeping oil prices high, even though demand slips. In both cases it doesn't seem like you
have a huge plunge."
For one, Dr. Alhajji says oil prices are manageable right now and that a short disruption in oil supply doesn't
necessarily spell doom for the economy.
"Energy crisis does not mean economic crisis. We define energy crisis as a case where you have
interruption in supplies. Oil prices will go up. This is not dangerous. It becomes dangerous if that high oil
price and [prolonged] interruption will stall the economy," he says.
Others aren't so optimistic. Even without the possibility of other Middle Eastern states shutting down their
spigots to the U.S., Mr. Baxter sees prices rising anywhere from $40 to $50 a barrel if the U.S. invades
Iraq, which translates to about $2.30 at the pump. He too says there could be trouble for the U.S. economy
if oil stays at the $40 a barrel mark for an extended time.
"The last time we saw that was during the oil embargo in 1999 and for a very short time after the Persian
Gulf War," Mr. Baxter says. "If it stays there for two months, it wears and tears on us through our whole
economy." |
