The Spillover Effect of $100 Oil

Rising oil itself can't cause a recession, but it affects the price of virtually everything consumers purchase

by Moira Herbst

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U.S. consumers are hurting. Amid the housing crisis, a weakening job market, and spiraling inflation, consumers are facing the toughest economic climate in more than 15 years. With crude oil prices hitting the once-unthinkable $100 milestone on Jan. 2 and now hovering in the mid-$90s, overall conditions aren't likely to be helped by a modest easing in crude prices.

That's because high oil prices have an inflationary effect throughout the economy. "When the price of oil goes up, it impacts virtually every commodity, good, and service we purchase," says Terry Clower, associate director for the University of North Texas' Center for Economic Development & Research. "Everything from milk to gasoline to a bucket of fried chicken will cost more. It's a potentially scary scenario."

Energy costs don't exert the same bite on Americans' budgets as they did in the late 1970s and '80s. But with oil prices nearly doubling in the past year, the cost of powering an economy that relies on a total of 22 million barrels per day has risen sharply. The Consumer Price Index increased 0.8% in November, its largest advance since September, 2005. Higher energy prices accounted for nearly 70% of that increase. Economists say that because Americans spend a lower proportion of their incomes on energy than 25 years ago, rising oil itself can't cause a recession. But with weakness in the job market, capital spending moderating, and the housing market in a full-blown crisis, the economy has reached a danger zone.

Airlines Boosting Fares

"The economy is getting death by 1,000 cuts," says Lester Lave, professor of economics at Carnegie Mellon's Tepper School of Business. "One-hundred-dollar oil alone won't cause a recession, but it could break the camel's back." A growing chorus of analysts agrees. "One-hundred-dollar oil could be the swing element," says David Wyss, chief economist at Standard & Poor's. (S&P, like BusinessWeek, is a unit of The McGraw-Hill Companies (MHP).) "If prices remain at this level, a recession in the first half of 2008 is likely. [But] most Americans feel a recession is already here."

The way most consumers experience higher oil prices is at the gas pump. The average price of a gallon of gasoline on Jan. 11 was $3.10 per gallon, up 38% from $2.28 a year ago, according to the Oil Price Information Service's AAA Daily Fuel Gauge Report.

Another direct impact is the cost of your weekend jaunt to Florida. U.S. airlines have boosted ticket prices at least seven times since September to combat rising jet-fuel prices, which jumped nearly 60% in the past year. Every dollar increase in the price of a barrel of crude oil drives approximately $465 million in annual fuel expenses for U.S. airlines, according to the Air Transport Assn., an airline trade group. Since jet fuel represents about a third of airlines' operating costs, domestic fares began rising $10-$20 or more within days of oil prices reaching $100 per barrel. "With increasing speculation about a slowdown in the economy, $100 oil will put pressure on carriers to generate additional revenues or find ways to cut costs to remain whole," says ATA Chief Economist John Heimlich.

Diaper Prices on the Rise

More surprising price rises will hit products with oil or oil derivatives as a main ingredient. Procter & Gamble (PG) hiked prices on a variety of products in 2007 to make up for the rising costs of the oil-based chemicals in cleaning products. It raised prices of fabric softeners like Downy by 9% in the fall and, in January, will impose an average 8% increase on Olay and Ivory personal cleansing products. "We will continue to take the necessary pricing actions to recover rising commodity and energy costs," Robyn Schroeder, a Procter & Gamble spokesperson, wrote in an e-mail message.