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business newsWhat $100 Oil Means for Our Recovery
By
Josh Lipton Jan 06, 2011 3:40 pm
Economists explain the impact of higher crude prices on the consumer. Hint: it's not pretty.
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The risks are just as well known: a lousy labor market, a soft housing market, and debt-burdened state and local governments. Here is another potential hand-wringer: the rising price of crude.
Strategists are now nervously eyeballing the price of oil as it hovers around $90 per barrel. The price has popped 6% since October and some forecasters have become worried. “Oil prices are entering a dangerous zone for the global economy,” Fatih Birol, the IEA’s chief economist, said this week.
The rising cost of crude -- driven not only by physical demand but also investment-related action -- is a concern for our economy, say economists and strategists, as they warn about its impact on our fragile recovery and the purchasing power of the American consumer.
Andrew Lebow, senior vice president for energy at MF Global in New York, outlines the major themes in the second half of 2010 explaining oil’s move.
“There has been a pickup in demand as the global economy has improved in both OECD and non-OECD countries,” he notes. “US demand, particularly in the fourth-quarter, came in much higher than most expected. This was on top of the continuing growth in demand from China, India and other Asian economies.”
That demand has led to a large draw in crude stocks, says Lebow. “A lot of the overhang has been worked off,” he says. “It still exists but it has been halved from where it was in the mid-year 2010.”
Oil reached a two-year high on December 6, at $91.51. The black gold finished the year up 15.2% at $91.38 a barrel. As of midday Thursday, it’s at $88.27.
Beyond fundamentals, however, the strength in oil prices is also due to very strong investor demand, says Gluskin Sheff’s David Rosenberg. “Looking at the near record net speculative long positions on the New York Mercantile Exchange, as far as light sweet crude is concerned, it is abundantly clear that this run-up in oil prices is not merely related to physical demand,” the strategist writes.
So, where do oil prices head from here?
Morgan Stanley’s team, led by Hussein Allidina, sees oil prices above $100 in 2011. Ed Yardeni of Yardeni Research says he wouldn’t be surprised to see the price of oil over $120 a barrel by mid-year.
For his part, Lebow sees the price of crude, in the first half of the year, fluctuating between $85 and $95, and then potentially hitting $100 in the second half. Risks to his call: one, global GDP doesn’t grow as strongly as expected and demand falters; two, OPEC ramps up production.
But, if energy prices do break above $100 and gasoline prices approach $3.50 per gallon, then there are potential consequences for an American consumer already struggling with high unemployment and a depressed housing market. Every penny at the pump drains $1.5 billion out of household cash flow.
“As people divert more money to gasoline then it means less money for discretionary purchases,” says Miller Tabak’s Peter Boockvar, adding, “Anything discretionary does get impacted.”
The SPDR S&P Retail ETF (XRT) -- which includes holdings like Whole Foods (WFMI), Priceline.com (PCLN), O’Reilly Automotive (ORLY), and Gamestop (GME) -- is up 30% in the past 12 months. It’s down more than 2% in these first few days of 2011 trading.
As for oil, Rosenberg reminds us, the rule of thumb is that a 10% increase in prices shaves off 2.5 percentage points off GDP. This then means that oil could now prove a near-one percentage point hit to GDP growth this year, he estimates.
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