Record Gas Prices Could Harm Economy

RAY SUAREZ:

Energy prices continue to rise. Inflation was up again today, due partially to higher energy costs. At the pump, gas prices reached a national average of $2.10 a gallon yesterday. Meanwhile, crude oil now costs more than $56 a barrel.

For more about these increases and their impact on both the global and U.S. economy I'm joined by Vijay Vaitheeswaran, the author of a book on the future of energy, "Power to the People." He is also the environment and energy columnist for the Economist Magazine. Nariman Behravesh is the chief global economist at Global Insight, an economic forecasting firm. And Neal Elliott is with the American Council for an Energy Efficient Economy, a nonprofit think tank that studies energy use and prices.

Well, Vijay Vaitheeswaran, even though the taps seem to be open all over the world and everybody says they're pumping as much oil as they can, prices continue to rise. Is there enough oil for all the people who want to buy it, for all the things they want to buy it for?

VIJAY VAITHEESWARAN:

I think there is, Ray. I think there is enough oil. But we are going to find some great volatility and some nervous times as we go into America's driving season, into the summertime. The reason is because the markets are tight. The demand picture is very strong globally and supply is just at the edge of where we need to worry about it.

RAY SUAREZ:

Are these record prices totally justified by, as you say, demand? Or is there also a little premium built into that per barrel price by worries about Russia, worries about Venezuela, and so on?

VIJAY VAITHEESWARAN:

You raise a very good point. There is certainly reason if you look at the fundamentals. Demand is very strong. It grew at the highest pace in 25 years last year, especially thanks to China. And supply is tight. But most people that look at the markets would argue that there is something on top. There is maybe a speculative froth, a fear premium as people in the marketplace call it. The main reason is in addition to the usual tightness of the market, we have al-Qaida, for example, issuing explicit threats against the Saudi oil infrastructure. We have terrorist attacks in Iraq. We have political problems in Venezuela, in Russia, in Nigeria; the market is on a knife's edge with very little spare capacity. And any one of these disturbances could be strong enough to push the oil prices much higher. So there is something in addition to the fundamental supply-demand balance going on.

RAY SUAREZ:

Nariman Behravesh, what kind of information, what kind of impulse does that latest oil news, these spiking prices send into the world economy?

NARIMAN BEHRAVESH:

Well, that's a good question. Basically the world economy so far seems to have shrugged off this oil price hike. And just to pick up on what was said earlier — it is a very different environment than let's say the oil shocks of the mid 70s and the 80s. It is a demand-driven price increase; it's because the U.S. is growing strongly, China is growing strongly. So the impact of that is somewhat less. It is in a way a more benign price increase than when you have a supply disruption, for example, as we had in the early '80s because of the Iran-Iraq War and the revolution in Iran. In those days, about 8 million barrels a day went off the market, basically. That would be the equivalent of about 12 million barrels a day today. If that were to happen today, oil prices would be at $100 a barrel. So we are not there. It's a very different kind of situation. So that's one of the reasons why the world economy basically shrugged off this event.

RAY SUAREZ:

Well, help me understand how it is possible for the world to shrug off record prices when oil is in so many things: Asphalt for roads, paint, plastics, fertilizer for the growing food needs around the world. If oil is in so many of these products, how can the world just shrug off $57 a barrel?

NARIMAN BEHRAVESH:

Well, there's basically two reasons. One is that we are actually using less oil per unit of output than we did let's say in the early '80s we are using half as much; that is to say the U.S. and other industrialized economies. So we are using about half as much oil of GDP or per unit of output. So in that sense, the vulnerability is a lot less than it used to be. The second point to be made is even though oil prices are high, they actually haven't kept up with inflation. To put things in perspective, gasoline prices as you were saying earlier now around a little over $2 a barrel, $2.10, if gasoline prices had kept on inflation, they would be probably closer to $3 a barrel right now. So actually our incomes and other prices have risen faster than gasoline and oil prices. So in that sense, even though there are record prices, they're not that high relative to how other prices have moved.

RAY SUAREZ:

Well, Neal Elliott, have American drivers joined the rest of the world in shrugging off that rising oil price?

NEAL ELLIOTT:

In a large part, yes. What we have not seen is a large change in driving behavior over the last six months, since the prices did go up. We are starting, however, to see some significant changes, however, in some of their purchase decisions related to their cars. We saw the price of SUV's last month, according to the Bureau of Labor Statistics fall 2.8 percent. We've seen a shift in consumer preference toward the so-called crossover SUV's and away from truck-based SUV's. So yes, they have made some choices. It's also not been uniform across the economy. The people who tend to have been most significantly impacted by this, have tended to be the low income, fixed income parts of the society, in addition to many of the energy intensive manufacturing companies that you mentioned who make the products like the fertilizers and chemicals and plastics we use. The high income parts of the economy have largely shrugged this off because energy costs are, in general, a fairly small part of their overall energy budget; the average household spends or spent about $3,000 a year on energy; about half for their car and about half for their house in 2002. Today that number is probably closer to $4600 with a disproportionately greater share being borne by the gasoline.

RAY SUAREZ:

Now, wait a minute. That's a 50 percent increase over the course of a very short number of years. Do we have any evidence that people are not buying other things because they are buying gas and home heating oil and natural gas?

NEAL ELLIOTT:

We certainly saw that last Christmas season. And if you look at the retail data out there, retailers like Wal-mart who tend to target more of the lower socioeconomic groups did have a soft Christmas. On the other hand, groups like Neiman Marcus in the luxury category had a very robust Christmas season. So we do see some disproportionate impacts in consumer behavior.

RAY SUAREZ:

Nariman Behravesh, is there any evidence that developing economies are going to make different choices and perhaps develop different industries, different ways of life because they are becoming wealthier at a time when gas is expensive?

NARIMAN BEHRAVESH:

It's hard to see that right now. I think there are sort of some predictable paths of development that you see for a lot of economies. They tend to start off as agrarian economies and then move to manufacturing and then to services, although there are some variations around that. But the probably the biggest economy right now or the one that's having the biggest impact on energy markets other than the U.S. is China. China is now the second largest importer of petroleum. And it's really China that in some sense is setting the pace here. So China and China's developments and China's industrialization are clearly one of the biggest drivers of this picture at this point in time. That's really not going to change that much in the next few years. So I don't really see the picture changing dramatically, at least for a while.

RAY SUAREZ:

Vijay Vaitheeswaran, one of the most common headlines in the last couple of years has been for oil companies to report, oh, well, never mind what we were telling you in the '90s, it turns out we have fewer reserves than we thought we did. Is there a crunch coming in the future as we're not finding oil as fast as we used to find it, new sources?

VIJAY VAITHEESWARAN:

There's two things happening with reserves, Ray. And the headlines are in part because there is a discrepancy between what official rules from the SEC, the Securities and Exchange Commission, and some very technical details on how to report how much oil you have that's considered crude. That's an arcane debate that most people probably wouldn't want to get involved with, and it's really a financial accounting issue. The company Royal Dutch Shell, which is one of the world's biggest, fell foul of that and it sacked its chairman in part because of a scandal that it missed booking reserves. But the question you ask is actually more profound and that's really looking at: are the big oil companies having a problem replacing their reserves, whatever the financial reporting says, and the answer is yes. What we are finding is that the great wave of exploration that happened about 30 years ago that brought Alaska, the Gulf of Mexico, the North Sea, these great oceans of oil, of non-OPEC oil that propped up the Exxons and the Mobils and the BP's for the last 30 years, well, these great fields are in rapid decline and quite frankly, big oil is in big trouble. The companies are not able to replace those very lucrative reserves very easily in part because the countries that have the rest of the oil or a lot of it anyway, countries in the Middle East, Russia, increasingly they're saying no, thank you. We don't need your help. We can do it ourselves.

RAY SUAREZ:

And Neal Elliott quickly before we go, is there a point in which it becomes harder for American consumers to so-called shrug off the price? Is there is a wall that the market will hit?

NEAL ELLIOTT:

We don't really know what the wall is. I mean we're hearing now forecasts of $2.50 a gallon for the average gasoline prices – summer — that means probably $3 plus in California. That is going to have some real economic impacts, particularly in the lower socioeconomic levels. And so I think you are going to see some changes in terms of consumer preferences. They may be slow but I think they are going to be real.

RAY SUAREZ:

Neal Elliott, gentlemen, thank you all.