Not Everybody at the Party Is Toasting Oil Prices’ Plunge
After a brief scare from OPEC’s price-boosting antics this spring, oil has stabilized once again at bargain levels. And that means an entire barrel still costs about the same as a so-so bottle of champagne. A gallon of gasoline can still be had for about a third the price of a bottle of Thunderbird.
Moreover, the failure of OPEC to significantly cut oil production suggests that these extraordinary prices will be around for a while. That means big-time celebrating for a wide range of oil dependents, from the obvious, such as airlines and freeway drivers, to the obscure, including the makers of Tupperware and toothpaste.
The ultimate celebrant, in addition to the White House, should be the consumer. The collapse in the price of oil boosts the economy by helping to hold down inflation. That, in turn, is preventing the U.S. economy from overheating--and helping to defuse other potential problems, such as the spread of the Asian economic crisis.
“The lower oil prices are, to some extent, mitigating the effect of the ‘Asian flu’ on the U.S. economy,” said Gordon Richards, economist with the National Assn. of Manufacturers. “What we’re losing in exports to Asia, we are partly making up in lower oil prices.”
Of course, not everyone is celebrating.
Among those staying home are oil companies; makers of small, fuel-efficient autos; promoters of alternative energy; and foreign countries--notably such poor nations as Mexico, Russia and Indonesia--whose fortunes are closely tied to the price of crude. Some marginal wells in the United States have been closed down, and the people who work them are taking pay cuts or losing their jobs.
But hydrocarbons remain so ubiquitous in industrial nations that today’s unexpectedly low prices benefit virtually every niche of the economy and ripple throughout the manufacturing chain, reducing inflationary pressure on countless products.
“It’s a plus for the economy as a whole to the extent that it puts more purchasing power in the hands of
households,” said Wells Fargo economist Gary Schlossberg. “This represents a tax cut for consumers.”
Except for the price of fuel itself, don’t hold your breath waiting for retail prices of goods and services to start tumbling because of oil deflation.
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Indeed, few companies can be exp ected to pass along oil-related savings to consumers in the form of lower prices, said Rajeev Dahwan, an economist with the UCLA/Anderson Business Forecast Project.
“If it’s just a blip in the road for six months or so, the producers are not going to change prices, because there’s a cost to changing prices,” Dahwan said. “I see this as a temporary reprieve.
“This will be a good pressure-release valve on profits,” he said. “It may put some extra profits into companies, which will balance off the rising wage pressures” that many companies are beginning to feel.
The price of crude oil, which stood at $23 a barrel as recently as September, traded as low as $12.80 in early March. A production-cutting agreement by the Organization of Petroleum Exporting Countries succeeded in pushing up prices to the $15-$16 range. On Friday, the May contract for light crude closed at $15.46 on the New York Mercantile Exchange.
Similarly, gasoline prices--bumping $2 a gallon in Southern California less than a year ago--tumbled below 90 cents last month before the OPEC deal and increased seasonal demand nudged them back up to just over $1 a gallon.
Those are 1960-level prices, when inflation is taken into account. And although the advent of warm weather always boosts demand and thus prices for gasoline, the outlook is for continued moderation.
“Current supply exceeds demand and stocks are high, suggesting a continuation of a difficult market for producers,” according to the Paris-based International Energy Agency. Supply exceeded demand by 1.5 million barrels a day in the first quarter of the year, the global watchdog group said.
Any company that makes a living by moving things around is enjoying lower costs.
Airlines spend more on jet fuel than anything else except labor. Fuel accounts for 12% of operating expenses, said David Swierenga, chief economist for the Air Transport Assn. of America.
A gallon of jet fuel sold for an average of 50 cents during the first quarter, down from 71 cents during the same period last year, saving the industry $900 million in fuel costs during the quarter, he said.
“It’s a pretty dramatic reduction in our cost structure,” Swierenga said.
So where’s the airline price war? “Market conditions are the prime drivers of fares,” not an airline’s costs, Swierenga said. “Lower costs make fares able to come down, and I expect they will eventually.”
Truckers, too, are happy to be paying less for their diesel fuel, which accounts for 30% to 40% of a trucking company’s overhead. So those lower prices can mean cheaper transportation for those shipping goods by truck, more profit for the trucker or both.
“What a welcome relief,” said Beau Biller, spokesman for the California Trucking Assn. “Even a small fluctuation in the price of fuel can make a big difference in the bottom line.”
Beyond the obvious fuel users are thousands of manufacturers that use oil and its products in making their goods, as the oil industry is fond of pointing out.
“Just look around your room,” says Joe Lastelic, spokesman for the American Petroleum Institute. “Maybe your computer, maybe your desk, your clothes, the carpet were all made using oil.”
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The list of products made using petrochemicals is astoundingly long: toothpaste, lipstick, paint, footballs, shaving cream, credit cards, roofing, bandages, insecticides, crayons, antihistamines, compact discs, antiseptics, ink, food preservatives, perfumes, and on and on.
Tupperware is made using oil products--plastic resins--and lower oil prices mean costs are down, although the Orlando, Fla.-based company won’t say by how much.
“We do expect our raw materials costs this year to be lower than last year because of lower oil prices . . , so that would be good news,” said Tupperware Corp. spokeswoman Christine Hanneman. “Usually it’s the other way around.”
But Tupperware won’t change its prices, she said, because raw materials account for only about 10% of the purchase price of the plastic storage containers.
“We price to what the market will bear,” she said.
The most obvious losers in the oil price collapse are the countries and the companies that produce oil.
Venezuela, for example, is planning to cut 1998 government spending for a second time because of falling crude prices. The government, which derives 50% of its revenue from taxes and royalties on the sale of oil, already has been forced to cut 6% from its 1998 budget.
Mexico’s government, which gets 37% of its revenue from oil, has twice had to slash its budget, reducing spending by a total of nearly $3 billion. The tumbling oil prices have revived a trade deficit for the wary country, which is in a tenuous recovery from a profound recession--one triggered by a trade deficit.
As for the oil companies, analysts predict that exploration budgets will shrink if prices stay down very long.
Unocal Corp. is the most visible example so far. The El Segundo-based company, which finds and produces oil and natural gas, said it will postpone $250 million of its planned $1.5-billion 1998 capital spending budget, or 17%, because of depressed oil prices.
“We have the flexibility and strength to weather this period,” said Roger Beach, Unocal chairman and chief executive. “We are taking a selective and preemptive approach to cutting our capital spending. We won’t compromise the long-term growth of the company.”
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Most major oil companies have been able to weather the price storm so far because technology now allows them to produce oil at a much lower cost. Thus they can remain profitable even at $13 or $14 a barrel.
But small independent oil producers, particularly those in California, have been hit hard. These companies pump oil from marginal wells, called “stripper wells,” that produce fewer than 15 barrels a day.
Many independent producers nationwide have shut down wells because the oil is too expensive to pump at current prices, said George Yates, chairman of the Independent Petroleum Assn. of America, which represents 8,000 independent producers who drill 85% of all U.S. wells and produce about 40% of the nation’s crude oil.
“The price of oil today is as low in real terms as we’ve seen since the second World War,” Yates said. “It’s a very serious thing--lots of blood on the floor.”
Three U.S. senators have proposed bills that would, among other things, provide tax credits for small oil and natural gas producers when energy prices are low and would reduce the royalties they pay on energy discoveries.
California wells in areas such as Kern County produce a syrupy oil that must be extracted with the help of steam, which increases costs.
“The recent collapse has put nearly all California oil producers under water, praying that the storm will pass before they have to take their last breath,” said Chris Hall, president of Drilling & Production Co., a small independent based in Torrance that has drilled for oil in Kern County for three generations.
Hall said some independents are giving employees a choice between a 10% to 20% pay cut or layoffs. His 10 employees, who work 60 wells, took a 10% pay cut.
“While everyone is out there enjoying the low prices for gas, this is having a measurable impact not only on the companies that produce the oil, but also on the employees,” Hall said. “If you’re going to have cheap oil--and everybody likes it--we’re going to have to pay the consequences of that.”
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Slippery Slope
OPEC’s failure to significantly cut oil production suggests that extraordinarily low prices for crude will be around for a while. Weekly oil closing prices on the New York Mercantile Exchange since September, plus latest:
Friday close: $15.46
Source: Bloomberg News
