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As oil prices continue to soar, talk of economic ruin subsides

WASHINGTON—When oil prices briefly touched $70.85 a barrel last August, many experts thought that such high prices, if sustained, would toss the U.S. economy into recession. Oil now hovers around $75, but this time there isn't much talk of economic ruin.

Economists now expect the high prices to shave the economy's growth rate some, but most think that the U.S. and global economies are resilient enough to weather the rising energy costs. A national average of $2.91 per gallon of gasoline provokes grimaces at the pump, but it's not high enough to send the economy into a tailspin.

What price would? Unfortunately, it won't be clear where such a tipping point is until we reach it.

"We really don't know the number. We're probably getting close to a point where we might find out," said Phil Flynn, a vice president and energy analyst at Alaron Trading Corp. in Chicago. "We haven't seen any sign that demand is faltering due to these high prices."

Just last year, many economists predicted $75 to $80 per barrel as an economy-busting benchmark. But now they've moved the bar higher.

"I don't think there's any cliff you suddenly walk off. I'm not going to worry about a recession until we get up to $100" a barrel," said David Wyss, chief economist for Standard & Poors, the credit rating service, in New York.

One reason he's not overly concerned is that energy prices haven't spiked so much as climbed over two years, allowing companies time to adjust.

"The economy is living with it, and corporations are turning in strong profits despite high energy costs," Wyss said. "People forget that energy isn't as big a part of the economy as it was 25 years ago."

James Glassman, senior economist with Wall Street powerhouse JP Morgan Chase, thinks oil already has hit the U.S. economy hard but that the shock was little noticed because it's the equivalent of a bruise on a galloping racehorse.

"We haven't really felt it in the last two or three years because we've been in a recovery," he said, noting that the rising oil prices merely put a drag on what otherwise would've been even more robust growth. "We would have had a much more normal run-up in the economy."

The fundamentals of supply and demand are the most important factors behind today's high prices. Spare production capacity in the OPEC oil cartel is thought to be only 1.5 million to 1.9 million barrels per day, in a world that consumes 85 million barrels each day.

That leaves little room for disruption, and there are plenty of disruptions:

_Iraq's oil production is 900,000 barrels a day below prewar levels.

_In Nigeria, political insurgents are keeping 530,000 barrels per day off the market.

_In Venezuela, production is 400,000 barrels per day below what it was before a 2002-2003 state oil-company strike.

_Production from the Gulf of Mexico is 330,000 barrels per day less than before Hurricanes Katrina and Rita.

"The world oil market is in the grip of a slow-motion supply shock, in which a $70 to $75 barrel price reflects an aggregate disruption of over 2 million barrels a day," Daniel Yergin, the chairman of Cambridge Energy Research Associates, said in remarks prepared for delivery Monday evening at a Washington energy conference.

The biggest market mover is Iran's standoff with the West over its nuclear program. Oil traders fear that Iran, the world's fourth-largest oil producer, may respond to the threat of economic sanctions by withholding oil from the market. And if there's a military confrontation, other vital Middle Eastern oil supplies could be threatened.

A new wrinkle—financial speculation in oil contracts—adds to price volatility. The oil crises of the late 1970s and early 1980s were provoked by geopolitics, but back then oil traded between buyers and sellers. Today oil trades in contracts for future delivery, and many people who are buying and selling contracts for oil never intend to take delivery of it.

They're speculators, jumping into the market on the bet that prices will rise further and they can make a buck on oil's climb. Their bidding helps drive up prices.

Speculators include lightly regulated hedge funds, pension managers and commodity investment funds offered by major Wall Street firms.

One sign of speculative fever: The New York Mercantile Exchange, where oil and other commodities are traded, set a new record last Friday for volume traded. The 1,420,734 contracts traded surpassed the previous record of 1,383,616 contracts on Aug. 30, 2005, a day after Hurricane Katrina struck the Gulf Coast, destroying oil infrastructure on land and at sea.

"We don't think that's the major reason for the increase in (oil) prices," cautioned Laurence Kantor, a managing director for London-based Barclay's Capital. Today's high prices are "a bit puffed up," he said, but the demand for oil amid tight supplies remains the driving factor.

Even optimists don't leave motorists much room for cheer.

"If we calm down after Memorial Day, which I think there's a strong possibility we can, prices will settle back down," said Flynn, the energy trader. "If we stabilize in the low to mid-70s, I think the economy is going to fare just fine."

That's still $3 a gallon gasoline, though.


(c) 2006, Knight Ridder/Tribune Information Services.

GRAPHICS (from KRT Graphics, 202-383-6064): 20060424 US gas prices, 20060418 Oil price

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