High price of oil brings big shrug

Fuel: Lacking a clear explanation for crude's rise, consumers don't know what to do.

October 24, 2004|By Tom Petruno | Tom Petruno,LOS ANGELES TIMES

Imagine that an impeccable source had assured you on Jan. 1 that crude oil would be near $55 a barrel by mid-October. Your investment assumptions most likely would have been dour.

The stock market? It would be trashed for sure.

The bond market? Long-term interest rates would have to be drastically higher on inflation concerns.

The economy? Probably racing toward recession.

But oil is indeed near $55 a barrel - up from $32.50 at the start of the year - and neither the financial markets nor the economy seem too distressed.

And if a recession is on the way, nobody told consumers. In September, retail sales jumped 1.5 percent, the biggest gain in six months.

The reaction, or lack of reaction, to record oil prices is partly a testament to the human spirit. People learn to cope with adversity.

But there is another reason oil's ascent has failed to generate certain expected responses: No one has a good answer for why, exactly, the price is where it is.

And without a good answer, each additional gain in crude's price is greeted with as much disbelief as fear.

Hope is involved, too, the hope that the faster oil rises, the faster it will come down. In free markets, price spikes usually end with a crash rather than with a gradual descent or plateau. (Think Nasdaq in 2000.)

As for the economy, analysts can't agree on the longer-term implications if oil fails to fall back soon. For example, are higher energy prices inflationary - or deflationary? Or maybe both?

By now, everyone who fills up a gas tank a few times a month knows, generally, why oil has surged this year. Global demand, and particularly Asian demand, has been stronger than expected.

On the supply side, for much of the year every week seemed to bring another threat of a production disruption in key supplying nations from Norway to Russia, from Nigeria to Venezuela.

After Hurricane Ivan swept through the Gulf of Mexico in September, fear of supply interruptions turned into the real thing, as many drilling rigs and pipelines were damaged.

And ever present in the oil market is the fear of a terrorist attack in the Middle East that would severely curtail production.

But what would the price of oil be without that fear premium built in? Pick any number, and your guess might be as good as that of a veteran oil trader.

"I don't think anybody on this Earth really understands the dynamics of the world oil market now," said Ed Keon, chief investment strategist at Prudential Equity Group in New York.

If trading in oil futures were limited to petroleum processors alone (actual users of the commodity), it's possible that the current price wouldn't be near $55 a barrel. But any speculator also can buy an oil futures contract - and nothing attracts speculators like a hot market.

"Why are you buying?" was asked of many investors during the dot-com stock bubble of 1999 and early 2000. The honest answer was, "Because they're going up." That mentality is necessary for a speculative frenzy.

Evidently, oil traders believe the world will be a significantly less dangerous place in a year. Oil futures for delivery in November 2005 are at $47 a barrel.

That discount also could reflect the belief that the global economy will have slowed sharply by then, reducing oil demand.

So far, however, predicting the economic effects of record oil costs has been as difficult as figuring what's really driving the price.

The cost of gasoline nationwide declined for much of the summer but has been soaring again since early September. Yet that failed to keep consumers out of the stores last month. The government's September retail report said demand was robust for cars, appliances and clothing, among other goods.

Susan Sterne, head of research firm Economic Analysis Associates in Greenwich, Conn., said rising energy prices don't have the same effect on consumers as they did 10 or 20 years ago because energy is a much smaller share of the typical family's total spending - 3 percent to 4 percent compared with 8 percent to 10 percent in the early 1980s.

What many consumers saved refinancing their mortgages in recent years far surpasses the extra expense they are incurring at the pump, Sterne noted.

Some analysts are more worried. Spending was surprisingly strong in September, but "the question persists: Can consumers keep it up in the face of rocketing energy prices and anemic job growth?" Merrill Lynch & Co. economists asked in a report sent to clients Oct. 15.

Federal Reserve Chairman Alan Greenspan, in a speech the same day, said the effect of higher energy costs on the economy was noticeable but "likely to prove less consequential to economic growth" than in the 1970s.

Ever the perfect hedger, however, Greenspan also said that the economic risk would grow if oil prices were to move "materially higher." Not surprisingly, he didn't quantify "materially."

The Fed's view is important, of course, because the central bank controls short-term interest rates.

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