NEW YORK (Dow Jones)--Crude oil futures have set their sights on the $100 mark, raising concerns that the inexorable rise of energy prices will do significant damage to an economy already struggling with a prolonged housing slump.
But a look back in history should provide worriers with some comfort: not only is the economy far more energy efficient than it used to be, but also the inflation-fighting credibility of the Federal Reserve since the days of Paul Volcker should help keep the ultimate cost to the economy under control.
Worries over the surging cost of oil have been part of the economic landscape for several years now.
When oil prices first exceeded $40 per barrel in 2004, there were dire predictions of what that would do to the U.S. business cost structure and to the economy's ability to sustain growth. The same concerns were expressed at $50 per barrel, then $60, and then again as the price crossed the $70 per barrel barrier.
Now, the much-quoted futures price has already passed $90. But to gauge cost pressures, the actual spot prices compiled by the Energy Information Agency of the U.S. Department of Energy are more useful. The EIA spot price in the week ended Oct. 12 was $73.39 per barrel. That is just over two times as high as the price was ($36.38) in the week ended Feb. 11, 2005, or an annual rate of just under a 30% annual rate of increase - a pretty significant gain.
The dramatic rise in oil prices over the last couple of years has - so far - failed to match the worst fears of many observers regarding the economic impact. The economy has avoided recession and, indeed, recorded near-trend growth.
That relatively comfortable outcome has been the result of businesses finding ways to economize on oil costs and to absorb some of the higher costs into their profit margins. Thus, only a portion of the increased oil costs has been passed on to consumers in the form of higher prices.
The Feared Impacts On The Economy
The increase in oil costs certainly has the potential to be an obstacle to growth and could exert an impact in two ways: through a widespread boost to distribution costs, which would raise the prices consumers pay for goods, and through higher consumer outlays for commuting and traveling by auto, rail and air.
Goods, whether imported or domestic-produced, have to be shipped to the point where they can be bought by the final consumer. Higher fuel costs raise the price of distribution, which is part of the ultimate price consumers and businesses pay for purchases.
In the 1970s, the attitude - especially at the Federal Reserve under then Chairman Arthur Burns - was that Americans should be sheltered from this increase in energy costs by an accommodative monetary policy, leading to stubbornly high inflation.
Under Paul Volcker's chairmanship, however, price stability became the Fed's central tenet. The perception that the Federal Reserve would raise rates if rising oil prices fed through to consumer prices forced companies to absorb some of the rising energy costs and offset them by finding ways of lowering costs elsewhere.
In addition, there have been increased efficiencies in energy use in the economy.
In 1970, the average American car consumed 830 gallons of fuel per year, but by 2004 average consumption had declined by nearly 33% decline to 557 gallons per year. For pickup trucks, vans and sport utility vehicles, fuel consumption declined 21% to 682 gallons per year in 2004 from 866 gallons in 1970.
At the same time, miles per vehicle increased 25% for cars to 12,500 miles per year and by more than 26% for light trucks to 11,000 miles per year.
Higher gasoline and diesel prices did what they were supposed to do: they induced greater efficiency.
Since the same week in 2004, retail gasoline prices have risen nearly 36% to $2.764 per gallon and diesel has risen 39% to $3.039 per gallon. That has led to further improvements in fuel efficiency in mileage.
Over this three-year period, consumers have paid an extra $1,215 if they drove cars or $1,487 more if they drove light trucks. Clearly, that extra spending cut into discretionary spending, but it was not such a burden as to cripple consumer spending.
(Moreover, there is further to go in price-induced gas efficiency. This week I bought gas in Westchester County, N.Y. for $2.85 per gallon. Last week, in Assisi, Italy I saw gasoline for EUR1.73 per liter, or EUR6.574 per gallon and $9.39 per gallon. Most of this higher price was tax. As a result, Europeans have made greater fuel efficiency than the U.S.)
Just as the rise in fuel prices has been pronounced in percentage terms, but manageable as a part of consumer budgets - the increase in costs has been manageable.
Businesses have accommodated the increase in transport costs and still managed an increase in profit margins: in the first quarter of 2000, corporate operating profits accounted for 9.6% of national income, that had improved to 11.7% by the first quarter of 2004, and improved further to 13.4% in the second quarter of this year.
Oil at $100 poses a risk to the economy, but it's a familiar risk that the economy has been able to deal with up until now.
Source: John McAuley, Dow Jones Newswires, 201-938-4425; john.mcauley@dowjones.com