US economy now faces $50-a-barrel oil

Lowest US oil inventories in 30 years may pinch consumers in heating and shopping season.

It is news the world doesn't need: the price of oil finally going over $50 a barrel - a level that, even adjusting for inflation, has not been seen in almost 15 years. And most energy experts don't think this is a spike - prices could still move higher - and stay relatively high for the next year.

If prices do stay high, they will act as a brake on the economy, by some economists' estimates, lowering growth in the year ahead by as much as a full percentage point. The timing is awkward: In another month merchants hope consumers will be thinking about holiday gifts, not their fuel bills.

Although oil prices have been high for some time, the latest push over the psychological $50 mark - in London, and hovering around that level in New York - is the result of a combination of events. There is enough geopolitical uncertainty from Iraq to Nigeria to keep the oil markets nervous. The US oil industry is still recovering from the damage done by hurricane Ivan, which not only knocked out some production in the Gulf of Mexico, but also kept tankers from unloading imports in New Orleans and Galveston. This has resulted in a sharp drop in US inventories to their lowest level in 30 years. "We won't see any real relief, any respite, until we see some increase in US crude inventories," says John Kilduff, a trader at FIMAT USA.

How high can prices go? Mr. Kilduff envisions short-term oil prices of $51 to $53 a barrel. And he says $60 per barrel is not out of the question, "if Iraq worsens and some other disruptions take place."

Over the longer term, however, some analysts see prices retreating as the high prices encourage nations to produce oil and demand starts to recede. "EIA's views is still that prices will drop below $40 a barrel by the end of next year," says Erik Kreil, an analyst at the Energy Information Administration (EIA) in Washington.

Yesterday, even the news that Saudi Arabia would increase its production to 11 million barrels of oil per day did not immediately reduce prices. Oil traders say they will have to see the production first to believe the ramp-up is possible. "This is a Saudi misstep, Aramco [the Saudi national oil company] said earlier that the additional production wouldn't be on line until the end of the year," says Kilduff.

Another factor in the oil equation is the spurt in global demand - almost an additional 2.5 million barrels per day. Much of this is moving to China where there is a combination of economic growth and the nation's build-up of its own strategic petroleum reserve. A reflection of this demand is a tight tanker market, which is raising the price of transporting oil.

In the past, high oil prices have preceded recessions. For example, in 1979, oil peaked at about $75 in today's dollars and that lead to a recession in 1980. Economist Bob Brusca of FAO Economics in New York says the high prices may prompt the Federal Reserve and other central banks to reconsider their tighter monetary policies. "If all the central banks stay on the side of tightness, it makes a slump more likely," he predicts.

However, David Wyss, chief economist at Standard & Poor's in New York, thinks the high energy prices will take about a full percentage point off the nation's gross domestic product next year. And, he says, "Christmas is going to be affected. We can only hope for global warming."

Auto dealers are already starting to feel the impact of consumer hesitation. According to Ward's AutoInfoBank, US car sales are down by 3 percent for January through August of this year, compared to the same period last year. But ironically, light-truck sales are up 2.9 percent.

Some car dealers say they haven't noticed a change in consumer behavior. Dave Albert, the owner of Brill's Auto Sales in Westfield, Mass., normally sells about 80 used SUVs a year. "I would have thought gas prices would have affected SUVs," he says, "but I haven't seen people buying less of them."

At Battles Buick Pontiac in Bourne, Mass., Art Wetmore, the general sales manager, says that SUV sales plummeted when gas prices rose to over $2 a gallon this summer. "The big SUVs stopped," he says. The company stocked up on passenger and higher-mileage cars. "And as soon as they started inching down, it started again." His concern is as a consumer, he says. He locked into a home-heating price of $1.39 a gallon last year. This year they locked in at $1.69 a gallon. "And I thought I was lucky to do it."

Home heating has been a major concern for consumers, says Maureen Sclafani, co-owner of Liberty Petroleum and Sclafani Petroleum. She says that gallon sales, on average, are down by about a third. It's been that way for about six months. "This is normally a pickup time of year," she says. "It's not picking up."

That may be because the price is so high and consumers are waiting to see if they will drop. The cash-on-delivery price is around $1.70among the highest she's seen for October in 15 years. The only other comparable price was once during the Gulf War.

Will the high prices affect the election? "I don't blame it on the president," she says. "He is dealing with a world situation that is unique. I don't think anyone could have predicted all of these factors occurring at once." But, she adds, "I do think there are steps that either party could take to loosen the barrels at little bit," such as slowing down the filling of reserves or working on alternate energy sources.

"I think for Mr. Bush to get reelected he has to address the energy situation," she says. "And Mr. Kerry has yet to [express] what he intends to do about the situation."