Oil's Rise Threatens U.S. Recovery

Oil may end up taking away the recovery's traction.

Energy prices, climbing all year as global economic prospects improved, have lately hit their highest levels since September, as tension in the Middle East has mounted. At $27.35 a barrel, the price of oil is up 38% this year. Gasoline prices have risen in turn: A gallon of gas cost $1.37 Tuesday on average, according to the AAA, up from $1.13 a month ago.

"Clearly the Middle East is in the worst state it's been in since the early '70s," says Tom Petrie of energy investment bank and research firm Petrie Parkman. "There's little basis to believe there's going to be any great breakthrough in the near to intermediate term."

Among the greatest dangers, says Petrie, is the possibility of war between Israel and Syria. That could lead to calls for some sort of oil embargo among Mideast oil-exporting countries. Given such risks, says Petrie, the rise in energy prices is rational.

Not good news for the recovery. A $10 swing in oil amounts to about a $200 billion burden on the U.S. economy -- a tax on consumers and companies alike. It is not for nothing that the last five recessions, including the mild one that apparently just ended, were preceded by jumps in the price of oil.

Stepping Back

Economists aren't too worried -- yet. Much of the recent price increases, notes Richard Berner, are consistent with the normal course of a global recovery. Demand is improving, but OPEC has yet to take back any of the production cuts they put through when prices were slumping.

In the normal course of things, OPEC will step up production, since it's in its best economic interest to do so. OPEC nations know full well that high oil prices in the past have led to weakened demand, new exploration and increased development of alternative energy sources. While it might sate your appetite in the short term, putting the goose that lays the golden eggs on the roasting spit never makes sense.

"If global demand is improving, and OPEC accommodates that, it will have a muted effect," says Berner. "If there's a genuine supply shock, that's a horse of a different color."

Representation

Energy prices have an outsized effect on the U.S. not only because, as an SUV-loving nation, we're gluttons for gasoline, but due to the way gasoline is taxed here. In Europe and Japan, there is a set tax on a liter of gas, but here gasoline is taxed based on a percentage of its price. As a result when energy prices drop, as they did last year, the U.S. gets a big benefit. But when they go up, the U.S. gets hurt worse.

Petrie believes that while prices might spike if some OPEC nations endorsed an embargo, oil wouldn't stay very far north of $30 a barrel for long. Beyond the immediate negative consequences to their economies, non-OPEC nations such as Russia and Mexico would seize on an embargo to further increase their market share.

Another plus is that the economy, while obviously weakened by the recent recession, is on the mend. Within the context of that improvement, says Berner, an increase in energy prices is not the problem it was in the latter part of 2000 and early 2001.

Northern Trust chief U.S. economist Paul Kasriel makes the additional point that the oil price spikes of the past have been accompanied by declines in money supply. They generally came at a point in the economic cycle where the Fed, fearing inflation, was sopping up liquidity. He doesn't see much wisdom in the Fed cranking up rates to combat a supply-led rise in prices.

"If the Fed tightens too aggressively, yes, we will have a recession," says Kasriel. "If you want to blame energy, go ahead."

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