Fear of oil supply disruption has pushed crude prices above $100 a barrel. But the bigger concern for economists—and for stock market investors—is how much and how quickly higher energy prices will trim growth prospects for a raft of oil-dependent industries.
On Mar. 2, as Muammar Qaddafi's forces attacked rebels on Libya's east coast, where the country's oil refining and shipping are centered, crude oil for April delivery climbed $2.60 per barrel, to $102.23, on the New York Mercantile Exchange. That was the highest settlement price since Sept. 26, 2008. The same day, Brent crude for April settlement rose 55¢, to $115.97, on London's ICE Futures Europe exchange. Brent's settlement price of $115.42 on Mar. 1 was the highest since Aug. 27, 2008. Gasoline for April delivery gained 4.61¢ cents to finish at $3.0295 per gallon in New York, its highest settlement since Aug. 27, 2008.
The price spikes have crunched airline stocks by more than 10 percent, but the market's view of other industries with high exposure to energy costs has been harder to read.
Temporary, or Lasting?
The market appears to be trying to assess the threat of higher oil prices, says Phil Sanders, chief investment officer at Waddell & Reed in Overland Park, Kan. "If it turns out this is a temporary spike, measured in weeks, there probably won't be much of a long-term lasting effect," he said. "If oil prices stay high for a long time, it becomes more concerning and the market starts to question the sustainability of the recovery."
Investors are taking some comfort, Sanders believes, from mounting evidence that the global economic recovery has gained traction. He cited the addition of 217,000 U.S. jobs by private employers in February, which could be confirmed by Labor Dept. data scheduled for release Mar. 4. The jump in oil prices hasn't lasted long enough to endanger the recovery, however fragile it remains, but there's concern that high fuel prices for an extended period will not only boost input costs but also erode consumer confidence, he adds.
Transportation industries, such as airlines and trucking companies, are the most vulnerable to rising energy costs. The price of Gulf Coast jet fuel has surged nearly 27 percent since the start of this year and is up more than 12 percent just since Feb. 18, reaching $3.13 per gallon on Mar. 1. If the price were to hold above $3 for an entire year, it would lower airlines' pretax income by $5.3 billion, assuming no change in revenue or other variables, Deutsche Bank Global Markets Research said in a Feb. 28 note.
The Hit to Airlines
The risk of another fuel-price shock contributed to a 7.9 percent selloff in the NYSE Arca Airline Index (XAL) so far this year, Citigroup (C) said in a Feb. 28 research note. The Airline Index was down 11 percent year-to-date on Mar. 2. Since fuel accounts for about one-third of airlines' operating costs, those stocks should become less attractive if fuel costs continue to rise, the note said. The International Air Transport Assn. (IATA) on Mar. 2 cut its 2011 net profit forecast for the airline industry to $8.6 billion from its December outlook of $9.1 billion, but left its outlook for North American carriers unchanged at $3.2 billion. The Geneva group, which represents 230 airlines worldwide, increased its average 2011 oil price assumption to $96, from $84, per barrel of Brent crude in December. It expects this will boost the industry's fuel bill by $10 billion, to a total of $166 billion.
If the price of jet fuel were to average the current $3.17 per gallon for all of 2011, airlines would need to increase their revenue by at least 10 percent to offset the added costs, says Helane Becker, director of equity research at Dahlman Rose. The airlines have raised prices six times since October 2010. Rather than continuing to boost fares, they're more likely to retire older, less fuel-efficient planes. She expects the industry as a whole to cut capacity 25 percent to 30 percent by grounding aircraft older than 15 years.
Becker has a "buy" rating on 12 carriers, a "hold" on six, and no "sells," but says her earnings estimates are much lower than consensus. She hasn't heard that other airline analysts are planning to reduce their 2011 projections. But Becker and her peers will all probably use the industry's February traffic numbers, which start coming out this week, to adjust their outlooks, she adds.
A Cause of Recessions
Some economists have calculated that each $20-per-barrel hike in oil prices shaves one percentage point from the growth rate of the U.S. gross domestic product, according to Deutsche Bank's Feb. 28 note. Energy price spikes have precipitated most of the past half dozen or so U.S. recessions. For airlines to be able to continue to raise fares without losing too many customers, U.S. GDP must continue to grow at a minimum of 3.0 percent and the industry needs to keep capacity constrained, the note said.
U.S. trucking companies are dealing with a 11.7 percent rise in the average national price of retail diesel fuel year-to-date as of Feb. 28, but they're effectively hedged, thanks to automated fuel surcharges that "don't need to be renegotiated every time fuel prices spike," John Larkin, an analyst at Stifel Nicolaus, wrote in an e-mail exchange.
Larkin hasn't reduced any of his earnings projections except for FedEx (FDX), which on Feb. 14 lowered the outlook for its third fiscal quarter of 2011, ended Feb. 28. Citing the impact of severe winter storms and higher fuel costs, FedEx cut its forecast to 70¢ to 90¢ per share from the 95¢ to $1.15 it initially projected. Larkin says he generally waits until March to adjust his estimates, since the first quarter often includes challenging weather and fuel price hikes.
Threat to Retailers
The impact of elevated energy prices on consumer discretionary companies appears more muted. Higher fuel costs are more damaging to retailers that cater to lower-income consumers, who spend a higher proportion of their total household income on energy and therefore are more likely to curb spending. Initially, that puts such companies as Kohl's (KSS), J.C. Penney (JCP), and Target (TGT) at more risk than upscale retailers such as Nordstrom's (JWN). But if price spikes persist, even luxury retailers' profits would be impaired, says Robert Plaza, a consumer staples and discretionary analyst at Key Private Bank in Cleveland.
Stephen Wood, chief market strategist at Russell Investments, isn't very worried about a consumer pullback due to higher gasoline and food prices. The surge in energy prices in the first half of 2008 showed that consumers were willing to tolerate higher gasoline prices than expected before they stopped their discretionary spending, he says. The economic and psychological limit seems to be $4 per gallon, but with fewer SUVs and other gas guzzlers on U.S. roads than three years ago, Wood notes, it might take more than that for consumers to tighten their purse strings.