Soaring energy prices bad news for the economy

The high cost of oil and gasoline could act as a tax on consumers and undercut the government's stimulus plan.

Once again, concern is rising about the price of oil and gasoline.

On Tuesday, the price of oil hit a record $100.01 a barrel, up some $14 in eight trading days. It's the second time since late December that the price has hovered at the $100-a-barrel level.

The sharp rise is already showing up at the gas pump: Between Tuesday and Wednesday, the price of gasoline rose 4 cents a gallon, reports GasPriceWatch.com. Since Feb. 9, gasoline prices nationally are up 10 cents a gallon, for an average price of $3.05 a gallon.

For the economy, the run-up could not come at a worse time. Many economists believe the US economy is teetering on the edge of a recession. Higher energy prices act as a tax on consumers, absorbing money that would normally be used to buy other things.

If energy prices remain this high – or go higher – they could begin to eat into the rebate checks that the government is planning to start sending taxpayers in May.

"This is bad for the consumer and the economy," says Dennis Jacobe, chief economist at the Gallup Organization in Washington. "It will be an offset to the fiscal stimulus everyone is talking about."

Motorists are paying much higher prices than they were a year ago. According to GasPriceWatch.com, gasoline prices are up 51 cents a gallon from a year ago, when the price of oil was closer to $60 a barrel.

On Wednesday, some of those price increases were reflected in a sharp rise in the Consumer Price Index, which rose by 0.4 percent in January, compared with December. Energy rose 0.7 percent. Yet even with energy and food excluded, the CPI was up 0.3 percent – much higher than the Federal Reserve would like to see.

The last time oil prices reached this level was at the end of December. Then, oil prices fell back to about $86 a barrel. Energy analysts talked about the price of a barrel of oil settling in for 2008 in the low $80s.

But since then, reports have surfaced that the Organization of Petroleum Exporting Countries (OPEC) might cut production when it meets in the first week of March. OPEC currently produces close to 30 million barrels per day. On Feb. 13, the International Energy Agency (IEA) cut its estimate of demand by 200,000 barrels per day to reflect the slowing US economy.

"If OPEC does follow through and cut, it's not very helpful to the market," says John Felmy, chief economist at the American Petroleum Institute in Washington. "Why cut at these prices?"

Mike Fitzpatrick, who heads up the risk management group at MF Global in New York, blames the latest spike on hedge funds or wealthy individuals buying energy futures as an inflation hedge. "The logic is that stock and bond markets are down, so the best bet is commodities," says Mr. Fitzpatrick.

But Fitzpatrick says the market is also being swayed by a number of small events, such as a small refinery fire in Texas, the continued sparring between Exxon-Mobil and Venezuela's president, and news reports that oil field violence is heating up again in Nigeria. "We're all scratching our heads," he says.

While oil traders are trying to understand the dynamics of their market, economists are worried about consumers as they watch oil prices tick up.

In Dayton, Ohio, people are doing less driving early in the week, when prices are higher (prices tend to come down later in the week), says Brad Proctor, founder of GasPriceWatch.com, which is based in Dayton. "People are adapting," he says.

Yet so far, consumers have shown some resilience. On Tuesday, Chicago-based ShopperTrak RCT reported that retail sales in February rose 5.9 percent for the week ending Feb. 16. For the month, it's running at about a 2 to 3 percent increase, says Bill Martin, co-founder of ShopperTrak.

"Call it moderate spending to this point, not too fast and not too slow," says Mr. Martin. "People are continuing to buy things that they need."

But the International Council of Shopping Centers is reaching different conclusions. On Wednesday, it reported no week-to-week increase in sales and it proclaimed in a press release that consumers were not in the mood to spend.

How much gasoline prices rise may have an effect on consumer confidence. "A change of 10 cents a gallon either up or down won't make much of a difference in confidence levels," says Lynn Franco, director of the Conference Board's Consumer Research Center in New York. "Following hurricane Katrina, some gasoline prices went up to $3.50 a gallon, and we had lines at gas stations. So there was much greater apprehension."

But Mr. Jacobe says his surveys are starting to show a sharp deterioration in consumer confidence. "It's down considerably from the first week of January," he says.

How high gasoline prices rise could well determine the effectiveness of Congress's attempt to stimulate the economy. In May, the first checks for $600 for individuals and $1,200 for couples (plus $300 per child) will hit mailboxes. Assuming that an average person drives 15,000 miles annually and gets about 17 miles per gallon, Martin estimates that his or her annual gasoline usage is 882 gallons. A rise of 11 cents a gallon would take about $97 out of his or her federal rebate check. A rise of $1 a gallon would take $882. "It is tenuous times we live in," Martin says.