Low Oil Prices: Mixed Blessing in California

It takes a lot of energy to make steel coils--$750,000 a month worth of natural gas alone at the Fontana factory of California Steel Industries--but that’s a third less than it cost last year, thanks to the collapse of energy prices.

The trouble is, the factory’s biggest customer has virtually stopped placing orders. The reason: The customer makes pipes that it sells to the beleaguered oil and gas industry, which isn’t buying much of anything these days.

But count California Steel among the winners in the state’s new cheap-oil economy; it attributes an overall rise in sales partly to energy-related gains by other buyers of its products. But the troubles of its chief customer illustrate why California’s experience with cheap oil since prices began to plummet last December has so far been a disappointment to many economists.

‘Worse Than Expected’

“The near-term effects have been much worse than I expected,” said Larry Kimbell, director of UCLA’s business forecasting project.

Despite the state’s ranking as the nation’s fourth-largest producer of crude oil, all the economic studies have projected California and its diverse mix of manufacturing, agriculture, tourism and other industries to be comfortably among the ranks of the beneficiaries when oil prices drop.

And indeed, the collapse in energy costs is proving a plus to many Californians and other Americans--principally through a deflationary effect on the cost of everything from gasoline, home mortgages and air fares to manufactured products. The state’s inflation rate is even lower than the nominal rate forecast a few months ago.

But the oil-price collapse has thrown more Californians out of work and slashed oil-related capital spending more steeply than some economists had expected, slowing the spread of the benefits through the rest of the state’s economy and prompting analysts to push back their good-news timetable.

Citing just such adverse effects of lower oil prices, Security Pacific National Bank has lowered its projected growth rate for the state’s economy this year to 4.1% from 5.7%--still stronger than the growth rate expected nationally, but a reduction of nearly $7 billion in goods and services from what the bank forecast several months ago. It now says most energy-related gains won’t be registered until late this year and 1987.

Expectations Lowered

“We have lowered our expectations for real growth in 1986, partly because of the energy industry’s problems,” said Thomas R. Graves, the bank’s chief economist. “We didn’t anticipate the negative effects of the oil sector’s cutbacks in employment and its scaling back in capital appropriations working their way through the system first.”

One need only note that the state’s four largest industrial firms are Chevron, Atlantic Richfield, Occidental Petroleum and Unocal to appreciate the damage their retrenchment is doing to the state’s economy. All four have implemented major cutbacks in employment and spending on projects.

The cutbacks will ripple through the companies’ multinational operations, and their California impact is not yet fully determined. But several thousand white-collar oil jobs in the state are being eliminated by the big oil firms, and their spending on California projects is being slashed by hundreds of millions of dollars.

Ripple Effect

The white-collar layoffs are in addition to the 5,500 workers in Kern County alone--most of whom worked for small, independent oil or oil-supply firms--whose applications for jobless benefits since February are attributed by state employment officials to the slump in the Bakersfield area’s oil patch.

It was once estimated that the ripple effect of lower oil prices would roughly double, to more than 400,000, the number of new jobs created in the state this year. But Graves said the oil retrenchment has prompted Security Pacific to lower to 4%, from 4.3%, its employment growth expectation--meaning about 37,000 fewer new jobs will be created in California this year than were expected last winter.

Chevron, which is eliminating about 1,500 California jobs, will spend about $90 million less in Kern County alone than it originally planned this year--a decline of nearly 50%, according to Northern California division manager Claude Fiddler.

Tax Revenues Slashed

Meanwhile, the sharply lower oil prices have slashed state and local tax revenues, reducing or delaying programs specifically dependent on oil money--notably capital projects in higher education. Now the Deukmejian Administration wants to place a $400-million bond issue on the November ballot to make up the projected oil tax shortfall.

While all this is going on, said UCLA’s Kimbell, the widely anticipated surge in consumer spending of all that money saved in energy costs has not materialized. And although there is evidence of energy-related increases in economic activity, much of it remains inconclusive.

“I assert that the winners have won more dollars than the losers have lost, but so far the savings haven’t been enough to trigger an explosion of spending,” Kimbell said.

“Big shifts are costly. Big shifts seem to produce traumas that the losers have to react quickly to and the winners don’t. But so far it doesn’t seem to be evening out. If you look out a year from now, it will probably be a net benefit.”

No Fuel Sales Explosion

California motorists bought a record 1 billion gallons of gasoline in both March and April, and the state’s monitoring of vehicle travel at 22 locations suggests a greater annual increase--about 6.1% so far in 1986--than in the five previous years. But Caltrans traffic analyst Joe Avis stressed that the numbers are tentative and uneven, and the major gasoline marketers in the state caution that they are seeing no explosion yet in fuel sales.

State officials expect 1986 to be a record tourism year in California, though the travel industry notes that it is hard to isolate cheaper energy from such factors as fear of terrorism overseas and the proximity of Vancouver’s Expo ’86 as an explanation.

Even so, much of the talk of a record year in tourism is “speculative,” said Tom Hanlon, head of the Palm Springs Convention Bureau. Of cheaper gasoline, Hanlon said, “The feeling here is that there is some immeasurable but positive influence.”

Auto Sales Decline

If so, motorists so far appear content to drive their old cars wherever they’re going--despite studies predicting that auto makers and their dealers will be a prime beneficiary of cheaper gasoline.

In April, the first full month of dramatically cheaper gasoline and the most recent period for which figures are available, new car dealers in the state actually recorded a 10% decline in sales, according to R. L. Polk & Co., which tracks automobile registrations. That mirrors the nationwide experience in which auto makers report that fuel prices are having no apparent effect yet on the number or types of cars being sold.

Economists credit the cheaper energy for playing a role in today’s lower interest rates, which in turn have heated up parts of California’s housing market. But Kimbell said construction of multi-unit dwellings--more than half of all California housing--has been dampened by uncertainties contained in pending tax reform legislation in Congress.

‘Sort of Normal’

Employment gains of 3% to 4% since November in such industries as lodging and service stations around the state are “normal,” Kimbell added. “Except for the cutbacks in (petroleum), everything looks sort of normal. If I didn’t know there had been a big decrease in energy prices, there’s nothing in the statistics to tell me except for the negatives in petroleum.”

Regulated utility rates, meanwhile, are only selectively lower. To offset the impact of the lower rates now being charged to such industrial users as California Steel Industries, the state’s two biggest gas utilities--Southern California Gas and Pacific Gas & Electric--have proposed higher rates for residential gas customers. The reason: Unlike industry, residential users can’t readily switch their burners to run on oil and thus are captive customers of the gas company.

Lower Cost of Fuel

Meanwhile, Southern California Edison boasts that the lower cost of fuel to power its boilers, representing nearly half its operating costs, enabled it to withdraw a proposed $700-million rate increase. Still, there has been a big electric rate increase during peak-load hours, complained Howard Wilkinson of California Steel.

As California Steel has discovered, even those who might be expected to gain the most from lower energy prices find it something of a mixed blessing so far.

Western Airlines is saving $9 million a month in jet fuel costs over what it was spending last winter--a savings of 20% to 25% in total operating costs, according to Glen L. Stewart, vice president of operations administration for the Los Angeles-based air carrier.

But Western complains that the lower fuel costs are contributing to the air-fare wars by enabling airlines to keep older, gas-guzzling planes in service longer than planned. That has touched off a scramble to fill the extra seats that have resulted.

‘Good News, Bad News’

“It’s sort of a good news, bad news situation,” Stewart said. “I don’t think we’d see fares cut this far if everybody was still paying 85 cents a gallon for fuel (versus 55 cents now). And the cost of the fare war has been much greater than our decrease in fuel costs.”

Said UCLA’s Kimbell: “Who’d be one of the most obvious candidates for a winner? The airlines. But the first quarter was the worst in the history of the airline industry.”

Of course, there are few complaints from those airlines whose older planes suddenly aren’t obsolete after all. And travelers enjoying the lower fares aren’t wringing their hands over Western’s situation.

Eventually, those kinds of pluses will outweigh today’s drawbacks, the economists insist--it’s just taking longer than expected.

“Our feeling is that most of that will kick in in the summer months,” said Jeanette Garetty, chief economist at Bank of America. “What we’ve seen so far is the depressing effects of the aggregate cutbacks in capital spending. The $1 billion that Chevron doesn’t spend is $1 billion that doesn’t go to employees and doesn’t go to the retail stores they would spend it in, and so forth.”

Consumer Spending Expected

UCLA’s Kimbell said it’s only a matter of time before California consumers begin to spend the money they’re saving on energy--an estimated $3 billion annually at today’s oil prices, according to Bank of America. And, representing about 65% of the economy, consumer spending is roughly six times as important as capital spending in its economic impact.

Garetty views the consumer-spending picture as brighter than either Kimbell or Security Pacific’s Graves do, and said the oil-facilitated lower interest rates “are starting to kick in. We can’t sort out the impacts yet, but the California economic numbers are coming in stronger than what we were seeing in December and January.”

A recent study for the clients of Data Resources Inc. of Lexington, Mass., purports to define the winners and losers in a cheap-energy economy. Consistent with California’s experience over the past several months, the study concludes that the benefits don’t peak until 1988-89.

The Biggest Winners

Moreover, the study concludes that the biggest winners aren’t necessarily those industries that use a lot of energy to make their widgets. They are more likely to be those whose widgets are desired by companies that have money to burn as a result of general economic growth spurred by cheaper energy.

Good California examples: Semiconductors and computers, logical beneficiaries of an expected increase in capital spending. The airline industry’s current problems notwithstanding, Data Resources also figures that Western and its competitors will eventually be ordering more new planes as a result of the lower fuel costs--boosting business for California’s big aircraft industry.

Whether a boost in orders for commercial planes would even begin to offset an expected huge falloff in defense-related aerospace spending over the next few years is problematic. But any new business by then in Southern California’s big military-industrial industry will be better than another kick in the pants.

Little-Noticed Side Effects

Lower oil prices will do little for farmers or the makers of farm equipment, Data Resources said: Their problems are too deep-seated to be materially improved by cheaper fuel or cheaper petroleum-based fertilizers.

Meanwhile, there have been some little-noticed side effects.

Students at the UCLA Law School who were counting on an expansion of the school’s nationally known program in clinical law--course work offering the students a close approximation of real-world practice--will have to wait a year.

They are getting a different real-world lesson instead: The nearly $400-million shortfall in tax income from California’s oil production is cutting deeply into higher-education capital projects, including the $7-million law school addition on which construction was supposed to begin this summer.

The Deukmejian Administration’s proposed $400-million bond issue would make up the shortage, caused by a decline in prices for oil pumped from state-owned lands. The law school project, and others, would begin next year if approved by voters.

Tax Collections Drop

In Kern County, where oil-related joblessness is costing up to $900,000 a week in unemployment benefits, tax revenues based on the value and economic life of the oil and gas underground are expected to fall by about 15%, or $40 million, according to assessor Jim Maples.

And in Long Beach, various tax collections from oil could drop from $28 million last year to as little as $6.3 million, the city’s Tidelands Agency says.

In theory, those government entities will enjoy higher revenues overall as employment climbs and businesses grow. Among the contributors will be an unlikely category of cheap-oil winners in California’s economy: oil refiners.

Because of tight supplies of gasoline during the past few months in California, companies such as Tosco, refiner of unleaded gasoline for about 450 independent marketers on the West Coast, have been able to charge more for their products.

The bad news is that Californians are paying several cents per gallon more for gasoline than motorists in most of the country. The good news for Santa Monica-based Tosco, which has been financially on the ropes for about four years, is high profit margins and a sharp increase in earnings.

“This could be one of the best markets to be in as a refiner,” said John G. Drosdick, executive vice president at Tosco.