Fueling Fears
Can the economy withstand $3-a-gallon gasoline?
Like millions of Americans, J. C. Calcote is stuck between a rock and a hard place when it comes to rising gas prices. Well, in his case, it's more like being caught between a pile of bricks and a hard place.
Calcote runs a brick-supply company in Amarillo, Texas, providing building materials for the booming construction industry. The problem: With fuel prices soaring, his small business now pays more than twice what it once did to have a 150-pound shipment of bricks delivered from the manufacturer. Besides that, keeping his forklifts gassed up cost $2,600 in June, up from just $1,352 a year earlier. Of course, Calcote's employees can't haul the bricks by hand. So what choice does he have but to grin and bear it?
Ditto for Monica Shane. Recently, the 28-year-old attorney has been taking numerous weekend trips between her home in Washington, D.C., and New York City. It costs Shane roughly $40 in gas to make the 500-mile round trip. But because she's preparing for a permanent move to the Big Apple, "I don't have a choice," she says. "I just try and find the cheapest prices."
Gut check. What was once an irritating pinch at the pumps has turned into a painful punch in the gut for Americans, as last week the average price of regular unleaded rose 18.2 cents to $2.55 a gallon. That was the largest weekly jump in 15 years, and in some places, the price has already passed $3 a gallon.
So far, skyrocketing gas prices haven't dealt the economy a knockout blow. Far from it. Consumers, whose spending accounts for roughly two thirds of the economy, aren't even close to getting a standing eight count. In fact, the closely followed index of leading economic indicators rose slightly in July. "The impact of record gas prices so far has been shockingly small," says Mark Zandi, chief economist for Economy.com.
Nevertheless, the unexpected surge in prices at the pump has certainly dealt a body blow to households--just in time for the critical back-to-school sales shopping season. Those sales are expected to drop as much as 8 percent this year.
Up until now, consumers have been able to deal with rising gas prices thanks to soaring home values and record-low interest rates, which have reduced the cost of financing debt. "Low rates buoyed growth and offset the drag caused by high gas prices," says Richard DeKaser, chief economist for National City Corp. But now that rates are on the rise, "at some point, the gas price drag will no longer be offset," he says.
Households have had more money to spend on gas because they've continued to pull equity out of their homes through refinancing ($59 billion in the second quarter and $43 billion in the first). But now the rise in gas prices means the economy, which is already reliant on the housing sector--70 percent of the rise in household net worth since 2001 has come from real-estate gains--will need home prices to continue to boom.
Zandi says the real effects of sky-high energy costs may not fully be felt until later this year. "The concern would be come wintertime," he says. "If prices are still this high and consumers face record home-heating bills while interest rates are rising--and can't get another home equity line of credit because it becomes cost prohibitive--then I'd start to worry."
Making do. Of course, many households are already worried about gas prices. Though still shy of the peak reached during the oil supply cutoff during the Iraq-Iran War in 1981--$2.95 per gallon when adjusted for inflation--last week's $2.55-a-gallon average was a nominal record. "It's killing me," says John de Freitas, a taxicab driver who lives in Alexandria, Va. "Gas is a business expense, but a lot of this business expense is a liability because you are spending money you don't have." De Freitas, 62, fills his car once a day, for around $35 at the pump. That's up $5 to $10 from a year ago. To compensate, he runs the cab's air conditioner only when he has passengers and keeps the windows rolled down when he's alone. It's a major inconvenience, especially during the humid mid-Atlantic summer. But with gas costing 43 percent more than it did in January, it's a price he has to pay.
It's hard to predict where gas prices are headed from here, especially since unexpected events like hurricanes can disrupt the nation's already-tight refinery capacity.
The catalyst for the most recent run-up was a string of breakdowns at a dozen U.S. oil refineries, representing 16 percent of the nation's capacity for converting crude oil into usable fuel for cars, trucks, and jets. Thunderstorms knocked out the power at the big ConocoPhillips facility in Wood River, Ill. Another power failure shut down a Premcor plant in Memphis. Most troubling, BP's huge 460,000-barrel-a-day Texas City, Texas, refinery, where 15 workers were killed in a March explosion, has been plagued with problems and operating well below capacity. In the past, a few refinery problems during the busy summer months would not have greatly stressed the gasoline market. But rising global demand for oil has sopped up all spare capacity.
The effects of the high fuel prices are starting to trickle down into parts of the consumer economy. Calcote's firm, Tascosa Brick, isn't the only company feeling the pain. Wal-Mart, the world's biggest retailer, last week announced disappointing second-quarter results, blaming rising fuel costs. The discounting giant said gas prices are not only affecting consumer demand, but they added $30 million in transportation costs last quarter and $100 million in utility bills. "All anyone needs to know is that after stripping out autos and gas, retail sales have been flat as a pancake in two of the past three and in three of the past five months," says Merrill Lynch economist David Rosenberg.
To make matters worse, consumers are starting to feel the secondary impact of rising energy costs in the form of increasing prices. Two years ago, for example, customers of Grand Events & Party Rentals in Memphis could get their tables, tents, and party items delivered for a mere $30. When gas prices started to rise last year, the company passed along the extra costs to customers. Door-to-door service is now $60. But Mark White, who runs the small business, says that's still just enough to keep the company's 16-truck fleet fueled up and out on the road daily.
Inflation watch. White's experience is typical. Last week, two key gauges of inflation showed that prices are rising at both the retail and wholesale levels, further diminishing consumers' buying power. The closely followed consumer price index is now up 3.2 percent over the past 12 months, largely because of a 14.2 percent increase in consumer energy costs. While the overall rate of inflation is in line with historic averages, it's still above last year's 2.7 percent.
Despite paying more at the pump, consumers haven't really changed their behavior much. According to a survey by CNW Marketing Research, consumers say high gas prices are their biggest concern. Yet only 3 percent say they have cut back on weekend travel or vacations. And only 13 percent have started to reduce the total miles they drive to save money.
Part of it may be that consumers spend far less, overall, on energy bills than they did in the past. Economy.com's Zandi says the average household spends 6 percent of its budget on energy costs, which includes gasoline, utility bills, and home heating. While that's up from around 4 percent in early 2002, it's still well shy of the nearly 10 percent spent on energy in the early 1980s.
Another reason consumers may not be changing their behavior significantly is that other economic signs look strong. The labor market is strengthening, albeit in fits and starts. Corporate profits are expected to have grown nearly 12 percent in the second quarter from last year, well above forecasts of single-digit gains (and they're expected to grow more than 13 percent in the third and fourth quarters). The manufacturing sector is actually performing better than expected. And household net worth, thanks to the booming housing market, has grown more than 8 percent over the past year. It could also be a case that "the consumer is looking at this and saying, 'I don't think these prices will last,' " says National City's DeKaser.
In fact, many economists expect prices at the pump will ease somewhat after Labor Day, when gasoline demand typically falls. Last week, crude oil prices briefly saw their biggest dip in four months as investors took profits on mixed news from the government on oil inventories. (It takes two to four weeks for such a drop to register at the pump.)
Still, most analysts don't think oil prices will fall to 1990s levels anytime soon. The oil spikes of the 1970s were caused by short-lived supply disruptions. But this run-up is due to an increase in demand worldwide, particularly in Asia. "Sixty-dollar crude is a realistic number mainly because of the incredible economic growth we've been able to have with oil prices at these levels," says Phil Flynn of Alaron Trading. "The economy can afford these higher prices."
For now, perhaps. The question is, for how much longer?
Pumped-Up Prices
The cost price of a gallon of regular unleaded regular gasoline is nearing 1981's record of $2.95.
[labels]
$1.79 Yearly average
$2.55 Last week's average
1970
'75
'80
'85
'90
'95
2000
'05
0
.50
1.00
1.50
2.00
2.50
$3.00
Prices are yearly averages through 2004.
Adjusted for inflation, prices are in 2005 dollars.
Source: Energy Information Administration
Stephen Rountree-- USN&WR
This story appears in the August 29, 2005 print edition of U.S. News & World Report.