Markets & Finance

Will the U.S. Slip On Oil?


The economy started 2006 extremely strong in spite of record oil prices and rising interest rates. An unusually mild winter across much of the country is part of the story, but the lack of worry by consumers and business about oil prices is an even bigger part. The question remains, will we continue to glide down the economic highway or slip on oil?

Oil prices have raised overall consumer prices and cut into household purchasing power, with hourly earnings in the nonfarm business sector up only 0.1% from a year ago. So far the higher costs haven't deterred buying, even buying of cars and other energy-sensitive items. Consumer confidence rose to 109.6 in April, its highest level since May, 2002, despite gasoline hitting $3 per gallon.

The major reason for the lack of reaction is that oil is less important to the economy than it once was. The average household spent only 6% of its income on energy in the first quarter of this year, vs. 8.2% in early 1981 and 6.6% in 1960, when gasoline was selling for one-tenth the current price. Incomes have risen, while energy use per capita has been flat.

BIGGEST USER. The result is that today, the U.S. economy needs only 0.22 tonnes of oil or equivalent to produce $1,000 of GDP (at 2000 prices), compared with 0.41 tonnes in 1971 and 0.35 in 1980. Oil, which produced 45% of world energy in 1971, accounted for only 35% in 2003, with increases in nuclear and natural gas use making up the difference.

We should do even better. The U.S. is still less efficient than the Organisation for Economic Co-Operation & Development average of 0.19 tonnes, but we were even worse relative to the average of 0.26 in 1980. Per capita, the U.S. uses 7.91 tonnes of oil equivalent per year, compared with a European Union average of 3.80 and an OECD average of 4.74. Some of this is inevitable.

Because of the size of the U.S. and the fact that it's relatively less densely populated, Americans drive more and use more energy. The climate also requires more heating and air conditioning than Japan or most of Europe. However, our love of big cars and our use of energy-inefficient home heating systems and appliances are byproducts of relatively low energy prices. In Europe and Japan, high gasoline taxes have pushed drivers into more fuel-efficient vehicles.

NOT AFRAID. The April data on car sales show little move to efficiency. Despite record gasoline prices, light vehicle sales edged up to an annual rate of 16.7 million from 16.5 million in March, and were only slightly below last year's total of 16.9 million. Although sales of large SUVs were down, light trucks still accounted for 53% of light vehicles sold. That's down only slightly from 55% a year ago and higher than at any time before 2003.

GM (GM), Ford (F), and Chrysler (DCX) suffered as buyers shifted to more fuel-efficient vehicles from Toyota (TM) and Honda (HMC), but the shift was not pronounced. Admittedly, light truck sales are holding up in part because manufacturers are offering large discounts to "move the metal," but the fact that buyers are responding to those incentives shows they aren't too scared of gas prices.

Americans continue to spend more than they earn, but gasoline prices will have an effect. Although the April chain store results suggest gasoline prices aren't hurting much yet, eventually Americans will be forced to realize that they have to slow down. We expect the economy to slow in the second half of the year as the impact of higher oil prices sinks in. How much the economy slows will depend on how high oil prices remain. We expect some drop in oil prices by yearend, but I have been saying that for so long even I am starting not to believe it.

BACK-UP PLAN. The anger against the oil companies is clearly misplaced. Exxon (XOM) and friends control only a small share of world oil reserves. Most are now in the hands of state-owned oil companies. The recent move by Bolivia to nationalize its industry is only the latest in a long line of similar actions. The history of these enterprises is one of severe underinvestment and mismanagement, which tends to reduce supply and keep prices high. The risk on oil prices is primarily on the high side of our forecast.

Although I think oil prices will drop back in the medium term, to address my serious worries, I'm buying my wife a hybrid bike for Mothers' Day.


Tim Cook's Reboot
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