Paying at the Pump
Could sky-high fuel prices signal the end of the country’s super-charged economy?

TWENTY years ago, President Jimmy Carter was confronted with a crude oil price run-up that led to drastically increased retail gasoline prices and an eventual severe economic recession. The situation was, he said, "the moral equivalent of war." Carter proceeded to institute price controls and gas rationing that produced blocks-long lines at filling stations. Many economists mused that Carter’s cure may have been more damaging to the overall national economy than the disease itself.

Today, U.S. Department of Energy Secretary Bill Richardson calls Saudi Arabia the "linchpin" of any pricing strategy by the Organization of Petroleum Exporting Countries (OPEC) and says the Saudis are America’s good friend and ally. The world’s largest single oil-producing nation has not forgotten that the U.S. went to war to keep Persian Gulf oil flowing out to Western markets, while also defending their country from Saddam Hussein. In sharp contrast to official U.S. policy under Carter, Richardson argues that the market alone should rule and that quiet diplomacy and low-key deal-making is the better answer to energy-related crises.

With the most recent "price-spike" in U.S. gasoline prices that occurred during February and March, it seems we have become embroiled in moral and economic warfare once again with the OPEC consortium. This time, however, it’s not personal or political, just purely business.

In January and February, Northeast U.S. heating oil prices surged more than 200 percent from last year’s levels, peaking around $1.97 per gallon in late February. By late March, per gallon prices for self-serve unleaded gasoline averaged $1.57 nationwide, according to the American Automobile Association.

Consumers have been asking exactly what triggered the latest oil crisis. The price of oil in 1998 plummeted dangerously low as producers, led by Saudi Arabia, boosted production in anticipation of growing demand from Asia – just as the Asian economy took a nosedive. The resulting oil glut on world markets drove prices to less than $10 a barrel and prompted OPEC and other producers such as Mexico and Norway to cut production quotas. Prices quickly tripled in a matter of a few months.

While supply and demand ratios might dictate that prices may go still higher this summer, almost two-thirds of those asked in a recent CNN-USA Today-Gallup poll said they think the high gas prices will be temporary and will not cause a rise in overall inflation nor pose a real threat to the longest-running U.S. economic expansion in the nation’s history.

However, federal government officials with the U.S. Energy Information Administration recently testified before Congress that with unprecedented 30-year low stocks in gas reserves and a market short on crude oil, the situation is ripe for further price volatility in the U.S. through the peak-usage summer vacation months. EIA is currently projecting regular gasoline prices to peak at $1.56 per gallon this summer across the nation. Price volatility could result in a 20-25 cent per gallon price surge in some areas, which could bring the price to around $1.80. Although these prices are far from record highs in real terms, they have risen rapidly over a short period of time, attracting a great deal of consumer attention.

If the EIA forecasts prove true, this could have dramatic effects on businesses across the nation and throughout the Commonwealth this summer. Tourists may scale back their vacation plans and stay closer to home, bypassing such popular destinations as Mammoth Cave National Park, which logged more than 2.2 million visitors in 1998 alone. With six national areas, 50 state parks, and hundreds of recreational, natural, historic, and cultural attractions, tourism and travel is Kentucky’s third largest revenue-producing industry, contributing $7.4 billion to the state’s economy in 1997. Tourism and travel is also the second largest private employer in the state, providing 146,738 full-time, year-round jobs.

Low energy prices play a large role in keeping overall inflation in check. When gas prices go up, the costs associated with doing business are directly affected. Ultimately the increases are passed on to consumers.

Despite most consumer fears, a majority of economists say high gasoline prices are unlikely to have any long-term effect on inflation as long as they don’t get built into the prices of other goods and services. So far, that hasn’t happened because most businesses continue to have difficulty passing increases in their own costs to the consumer in most markets.

However, at least one prominent Kentucky economist disagrees with the optimistic majority views of many of his peers.

"I am very concerned that the American public and our national government officials are not giving enough importance and attention to this increase in oil and gas prices," contends Prof. Charles F. Haywood, National City Bank Professor of Finance at the University of Kentucky’s Gatton School of Business and Economics. "The prevailing view is that it is only a matter of time until OPEC members cheat enough on their restrictive quotas to bring prices down again. However, it is also only a matter of time until the high oil prices result in ‘cost push’ inflation throughout the economy. If ‘cost push’ inflation takes hold, the Federal Reserve will need to adopt a much more restrictive monetary policy, as it did in late 1979. Interest rates would increase sharply, the economy would turn into recession, and the financial markets would become disorderly.

"A call by the President for voluntary rationing by consumers would probably not have much real effect, but at least it would be a first step to fight the high oil prices and it might be enough of a signal to OPEC that they would loosen a bit more their restrictions on oil supply," Haywood continues.

Most economists agree that it is important to keep in mind that the world has indeed changed in terms of what now prompts "energy market shocks." Today’s oil and gasoline price shocks have little in common with the Arab oil embargo of 1973 and the price upheavals of the Carter years. Now the politics and spirit of confrontation has drained out of the oil markets and it’s much more a business of buying and selling to make profits as opposed to trying to score political shots and messages.

Robert Ebel, an energy and national security expert at the Center for Strategic and International Studies, has said even OPEC’s most militant factions today "understand they need us just as badly as we need them and that we give value to their oil."

The 1970s and early 1980s was a time when many economists and environmentalists feared that oil prices of $80 a barrel or more would soon become a permanent part of the economic landscape. Some worried, erroneously, that the world was running out of oil and that we were seeing the beginnings of an "energy crisis" that would have to be addressed across the board and around the world. And the energy efficiency and alternative fuels movements had yet to catch on.

On top of that, economic times were tough: double-digit interest rates, a nine percent inflation rate and unemployment approaching eight percent. The crisis mentality prompted a series of government actions that most economists now acknowledge made things worse – gas rationing, price controls and the heavy hand of regulation, interfering in the energy markets.

While more oil is imported today than in 1973, less of it is concentrated in the volatile Middle East. More important, say economists, the United States is less dependent on oil today. Once widely used by industry, at power plants and for heating, oil now plays a modest role in non-transportation sectors.

Even in transportation, where oil still dominates, there have been dramatic changes. While $2 per gallon gasoline may bring sticker shock, motorists today are paying eight cents a mile for gasoline as opposed to 1973, when they were paying 12 cents a mile, and in 1979, 16 cents (both figures adjusted for inflation). Another key factor is that in 1970, the average car got 13.3 miles per gallon. Today, even with the popularity of gas-guzzling sports utility vehicles, the average is 19.4 miles per gallon.

"We’ve seen a noticeable increase in consumer interest of more fuel-efficient cars and less interest in the bigger SUV and truck models this spring," says Frank Guagenti, general manager of Johnny Watkins Buick-Pontiac-GMC and Chrysler Center dealerships in London. "Both the new and used car markets are showing these trends."

Consider the effects of rising gas prices upon a company such as United Parcel Service, the world’s largest express carrier and package delivery company. In 1998 alone, UPS delivered more than three billion packages and documents worldwide. To a company such as UPS, which maintains a fleet of thousands of vehicles and planes, rising fuel costs can be a huge concern. UPS last announced a modest rate increase that took effect on February 7, before the impact of the most recent round of fuel price increases was felt. Express rates for Next Day Air and related air-carried services increased 3.5 percent. The UPS Ground Commercial increase was around 3.1 percent across all weights and zones. These increases no doubt helped the company absorb some of the costs from the unanticipated gas spikes, but exactly how much is hard to determine this early in the game.

Major U.S. airlines, including Delta, which has a major connector hub at the Cincinnati/Northern Kentucky Airport, recently announced promotional packages with deeply-discounted fares to popular destinations in an attempt to drum up slow business, despite having to pay as much as a third more for jet fuel over the past two months.

Delta and its partner carriers operate more than 5,465 flights each day to over 364 cities in more than 61 countries. Accordingly, gas and oil spikes can run into millions of dollars in unanticipated overhead operating costs in a matter of weeks.

Truckers, too, are discounting rates, bidding for competitive market share. However, since its peak on March 13, retail diesel has slipped 5.4 cents. This has the trucking industry optimistic that some small amount of relief may be at hand, at least for awhile.

The inflationary effect has been minimal so far in the manufacturing sector. Chemical, plastics and other crude oil-using manufacturers saw the cost of that raw material jump more than 35 percent between January and April. Those increases will be reflected in the Producer Price Index (PPI), which rose by a smaller-than-expected 1.0 percent in February according to the U.S. Department of Labor. Prices for finished goods, other than foods and energy, advanced a mere 0.3 percent in the same time frame, while the crude goods index gained 4.2 percent, following a 2.7-percent rise a month earlier.

However, the worst may be over. The price of energy and gasoline is already beginning to come down around the country. OPEC’s recently announced production increases will take up to three months to reach U.S. shores, but the good news is that they will arrive just as the summer vacation season is hitting full stride.

Short-term, most experts agree there’s no doubt the spike in prices has had an impact. However, oil prices haven’t been high enough for long enough to seriously impact inflation, most analysts say.

In fact, the inflationary effect seems to be going the other way. Consumers paying more for gas have less to spend elsewhere, helping keep inflation down. Economists say that over-anxious consumers need to remember one of the basic principles of Economics 101:An increase in the price of a particular item or commodity alone is not inflation. Inflation is an increase in the overall price level of goods and services over a certain period.

The economy, meanwhile, has continued to grow, and that, combined with low inflation, has kept the Federal Reserve on the sideline. Most experts agree that’s key because the Fed increased the money supply in the ’70s in part to compensate for the oil price shocks of those years. As long as the Fed doesn’t repeat that critical mistake – and experts concur that’s unlikely to happen under inflation-conscious Chairman Alan Greenspan’s watchful eye – it should be a pretty safe bet that we won’t see higher gasoline prices impact inflation.

Richard Adkins (editorial@lanereport.com) is a staff writer for The Lane Report.

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