Oil Price Cuts Will Curb Inflation, Jolt Producers
For the airline industry, the travails of the Organization of Petroleum Exporting Countries--and the collapse of its pricing structure earlier this month--had all the earmarks of an unmitigated boon.
Jet fuel, after all, accounts for an average 30% of airlines’ costs.
However, nobody is celebrating at Alaska Airlines, even though each decline of 1 cent per gallon in the price of jet fuel saves the carrier $1 million a year. Alaska Airlines officials are keenly aware that lower petroleum prices will depress economic activity in the oil-dependent state, whose routes the carrier dominates.
“Lower oil prices are a double-edged sword for us,” said Lou Cancelmi, Alaska Airlines spokesman. “While they have a salubrious effect on the gallon we buy today, maybe there won’t be as many people and as much cargo traveling to, from and within Alaska.”
Alaska Airlines’ experience illustrates the swirling crosscurrents that have accompanied the plummeting price of oil, which is trading for about $26 a barrel for a key grade, Texas light crude, compared to $32 as recently as November.
Further declines are likely as OPEC nations make good on their vow to seek their “fair share” of the world oil market. Experts predict that this new price shock will roil world markets for years to come, harshly penalizing oil firms and oil-producing nations while showering benefits on consumers, keeping inflation in check, and stimulating growth in large industrialized countries.
Just as rising oil prices caused inflation and stagnation in the ‘70s, falling prices could lead to an era of non-inflationary growth, many economists say.
“It’s like getting over an illness,” said Bernardo Grossling, adviser to the Inter-American Development Bank in Washington, who contends that high oil prices “asphyxiated” the world’s most productive economies.
Consumers Will Benefit
Airlines, auto makers, home builders, truckers, tire companies--indeed, any company that is a net consumer of petroleum products and whose fortunes aren’t linked to those of the energy industry--will benefit, as will motorists and people who heat their homes.
For the United States and most other industrialized nations, lower oil prices are “unambiguously positive,” said Allen Sinai, chief economist at Shearson Lehman Bros. Inc., the New York investment firm.
The United States consumes 5.7 billion barrels of oil a year, 30% of which is imported, according to the American Petroleum Institute. That means that an average price cut of just $5 a barrel will free up nearly $30 billion for increased investment and consumption of consumer goods. Energy consumers will also see further savings as gas and coal producers are forced to cut prices to stay competitive with oil, analysts say.
For the industrialized nations, lower oil prices will be “as stimulative as a tax cut,” said Edward Yardeni, chief economist of New York’s Prudential-Bache Securities Inc. Moreover, plummeting petroleum prices will dampen already modest inflation expectations, allowing the Federal Reserve Board to ease credit and cut interest rates, economists say. And lower prices will aid the nation’s balance-of-trade picture by reducing the dollar value of imported oil.
However, the windfall for the industrialized nations will not come without a price, and in some cases it could be a frightfully heavy one.
There will be plenty of losers. Among them will be oil and gas producers, pipeline companies and banks that lent money to energy concerns and to such troubled oil exporters as Mexico, Venezuela and Nigeria.
‘A Sharp Challenge’
Oil at $20 a barrel “would pose a sharp challenge to the world financial system,” warns William Cline, senior fellow at the Institute for International Economics, a Washington think tank. Like most economists, however, he thinks such strains would be “manageable” with special assistance from either the U.S. government or international financing agencies such as the World Bank.
Nobody is predicting similar bail-outs for overextended drillers in such U.S. energy-producing states as Louisiana, Texas and Oklahoma.
“A lot of people who never should have been in the oil business have already been weeded out by falling prices,” said Richard Flashnick, president of Dallas-based Ram Resources, a small oil and gas exploration company. “Now, we’re getting to the point where the good-quality people who overextended themselves are in danger of falling prey to the same situation.”
Experts say the extent of the suffering will be determined by how far and fast prices fall.
‘Pain Threshold’ Cited
“The pain threshold differs from place to place,” said Donald Ratajczak, director of economic forecasting at Georgia State University. “At $22 a barrel, Texas shudders but it doesn’t collapse. At $15, you’re talking about Texas’ becoming an underdeveloped nation.”
Meanwhile, he noted, such oil exporters as Mexico, Nigeria, Venezuela and Indonesia “are already in pain” and will have a harder time repaying their huge international debts.
The situation in Mexico, which owes international banks and agencies almost $100 billion and is struggling to recover from the devastating earthquake this year in Mexico City, is considered especially worrisome. Mexico derives 75% of its export income and half of its government’s revenues from oil; for each $1-a-barrel drop in the price of oil, it loses $500 million in revenues. The revenue losses are only partly offset by lower interest rates, economists say.
Troubled Debtor Nations
While lower energy costs will provide some relief to troubled debtor nations such as Brazil and Argentina that are net oil consumers, the world debt crisis could be aggravated as oil producers are pushed closer to the brink.
“Lower oil prices will cause a concentration of the world-debt crisis on the oil-exporting nations. But a concentrated problem may pose as much risk to the overall system as a milder but more generalized problem,” Cline said.
Saudi Arabia, Kuwait and other Arab oil powers are not in danger of defaulting on loans because over the years they have built up large financial reserves. Still, falling oil prices could exacerbate domestic recessions and will likely lead to a continuing decline in their political influence, geopolitical specialists say.
‘Geopolitical Clout’
Falling oil prices have already “substantially diminished the political geopolitical clout of oil-producing nations,” said John Lichtblau, president of the Petroleum Industry Research Foundation in New York. “Their clout consisted of their wealth and their ability to create a shortage by withholding production.” Lower prices have diminished their wealth, while excess worldwide production capacity has blunted--some say eliminated--the once-feared “oil weapon.”
In the United States, the Northeast and Midwest will get the greatest economic lift, while such energy-dependent states as Texas, Louisiana and Oklahoma will suffer. State and local governments in Texas, for example, lose between $80 million and $100 million in tax and royalty payments for every $1-a-barrel drop in the price of oil, according to Bernard Weinstein, director of the Center for Enterprising at Southern Methodist University in Dallas.
“I wouldn’t want to be the state treasurer in Texas,” said Benjamin Zycher, a Southern California economist and formerly a petroleum specialist with President Reagan’s Council of Economic Advisers.
‘Economy Is Better Off’
Still, Zycher calls talk of a banking crisis “absolute nonsense.” When oil prices fall, he said, “the economy is better off. That doesn’t mean that everybody is better off. But the gains to the winners far exceed the losses to the losers.”
However, the gains will also take time to materialize, and in some cases may be masked by other factors. All other things being equal, each $1-a-barrel decline in the price of crude oil should result in a 2.5-cent-a-gallon decline in the price of refined products.
Truckers complain, though, that rather than going down, diesel fuel prices have actually climbed a few cents a gallon in recent months to an average of $1.32 a gallon.
“It’s the old law of supply and demand,” said Jim Johnston, who drove a rig for 13 years and is now president of the Owner-Operator Independent Drivers Assn.
“Diesel fuel is competitive with home-heating oil, and the cold winter has drawn down the supply,” he said. “At least, that’s what the oil companies are telling us.”
Taxes Higher on Diesel
Diesel fuel was about 10 cents a gallon cheaper than gasoline during the ‘70s but now costs more because of higher state and federal taxes.
Taxes could go still higher. There have been growing calls recently in Congress for a federal excise tax on imported crude oil as a relatively painless method of helping to reduce the budget deficit. The levy would offset the drop in the price of imported crude and encourage continued conservation. The tax would provide a pricing umbrella for domestic producers, allowing them to raise prices and boosting the government’s take from the windfall profits tax on domestic oil.
Regardless of whether such an excise tax is enacted, gasoline prices will not fall as much as they once might have. Refiners’ costs will rise as a result of new federal regulations, effective Wednesday, that lower the maximum allowable level of lead to one-tenth of a gram per gallon from the current level of one-half gram per gallon. It takes more crude oil to make unleaded or low-lead gasoline because such gasoline must have a higher octane level.
Lower Lead Levels
“The primary domestic influence on gasoline prices is going to be the move to lower lead levels in gasoline,” said oil analyst Daniel Lundberg, president of the North Hollywood-based Lundberg Survey. Refiners will likely pass on to consumers the costs of refitting their refineries.
Still, many in the oil industry expect the price of gasoline--even the relatively more expensive unleaded variety--to fall below $1 a gallon in 1986.
“I’ve already seen $1 a gallon for leaded regular, cash, self-serve,” said Thomas Burns, assistant general manager of Chevron Corp.’s economics department. “There will be some unleaded gas available at that level or lower.”
He acknowledges, however, that such predictions are fraught with uncertainty. “My predecessor is famous for saying in 1978 that gas would never top $1 a gallon,” he remarked with a laugh.
OPEC’s Problems
Moreover, he said that experience has shown that when prices fall, “people who previously took the cash discount go back to using their credit cards, and people who used the self-service lines figure they can afford to have someone pump it for them.”
Besides lower prices, OPEC’s problems--and the vast strategic reserves established by the United States, Japan and other oil-consuming nations--should assure steady supplies of petroleum products. The U.S. Strategic Petroleum Reserve stands at 500 million barrels, serving as a hedge against future supply disruptions.
“Nobody’s worrying about where the next barrel of oil is coming from,” said Lewis Freeman, vice president for governmental affairs of the Society of Plastics Industry Inc., a trade association. Lower prices will be a plus for Freeman’s industry because plastic is made from oil-based chemicals, but they won’t be a panacea: Worldwide excess production capacity will continue to hurt.
Growing Surpluses Seen
And while some warn that lower oil prices might spur consumption and make the United States vulnerable to another supply disruption somewhere down the line, most observers see world oil surpluses growing rather than shrinking.
“The war between Iran and Iraq is going to end eventually, and that will add 4 to 5 million barrels a day to the world’s oil supply,” economist Zycher noted.
Moreover, world oil consumption, which used to grow in lock step with world economic growth, is now growing only half as fast because conservation efforts that were planned in the late ‘70s and early ‘80s are now implemented and producing results.
Gas-Guzzling Monsters
Says John Baden, director of the Maguire Oil and Gas Institute at Southern Methodist University: “No matter what happens to oil prices, we aren’t going to rip the insulation out of our houses or rush to trade in our Toyotas and Saabs for gas-guzzling monsters.”
U.S. oil consumption rose slightly in 1984, a year of strong economic growth, to 15.7 million barrels a day from 15.2 million barrels a day in 1983. Even as prices fell, consumption actually fell slightly in 1985 to 15.6 million barrels a day and is expected to remain at that level next year, according to the Petroleum Industry Research Foundation.
“The whole system is moving towards energy conservation,” foundation president Lichtblau said. “You’ll be able to have a lot more cars 10 years from now and still use less gasoline, and the same is true in many other areas.”
