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High energy prices fuel recession fears

Consumers and businesses are feeling the pinch from record-high energy prices. Already there are worries the country could fall into recession if $2 per gallon gas keeps going up.
/ Source: The Associated Press

Consumers and businesses are feeling the pinch from record-high energy prices. Already there are worries the country could fall into recession if $2 per gallon gas keeps going up.

Oil price shocks have played a role in four of the last five U.S. recessions over the past three decades. Analysts fear that attacks on oil facilities in Iraq and Saudi Arabia and the threat of further disruptions will keep prices volatile for some time.

“It could cause a recession if oil prices go high enough,” said David Wyss, chief economist at Standard & Poor’s in New York.

The price of light crude oil hit a record of $41.85 in New York trading early last week before settling at $39.93 on Friday. The markets reacted to the announcement that Saudi Arabia will begin pumping an additional 500,000 barrels of crude per day beginning in June.

That decision will have little immediate effect on pump prices in the United States, analysts said. The additional supplies will not reach this country until mid-July, after the demand for refineries to produce gasoline for the peak driving season has ended.

In another development Sunday, Energy Secretary Spencer Abraham said the Saudis had promised to raise their daily production by 2 million barrels, to 9.1 million. Also, Abraham said in a news conference in Amsterdam, Netherlands, that Saudi Oil Minister Ali Naimi told him in a private meeting the kingdom was willing eventually to “meet all requests up to their full capacity of 10.5 million barrels a day.”

Higher energy prices will crimp consumer spending. They act like a tax: If people pay more to fill up their cars, they have less to spend on other things.

The burden is not felt by just drivers of gas-guzzling sport utility vehicles.

Taxicab riders in the nation’s capital and elsewhere are stuck paying fuel surcharges. Airlines are raising ticket prices to cope with the higher cost of jet fuel. Trucking companies are boosting delivery prices.

Energy-intensive industries such as chemical and paper manufacturers have begun to increase prices to cover higher production costs. Even the local lawn service is having to shell out more to keep its mowers and trucks moving.

Crude oil prices have risen by about $10 per barrel since late last year. If that increase were to be sustained for a year, it would shave about $50 billion from consumer spending and reduce overall economic growth by about one-half of percentage point in 2005.

The optimists among forecasters point to a drop of nearly $2 per barrel in oil prices at the end of last week to support their view that the run-up will not last, and prices should return to about $35 per barrel or less by the fall.

Of course, events in the Middle East could prove the optimists wrong. More attacks on oil facilities, especially those in Saudi Arabia, could lift prices to $50 a barrel or beyond.

“We have a fear or war premium built into oil prices now of up to $15 per barrel,” said Sung Won Sohn, chief economist at Wells Fargo in Minneapolis. “The Middle East situation has to stabilize for oil prices to fall on a sustained basis.”

While economists believe oil prices will moderate in the months ahead, they said the recent sharp jump needs to be kept in perspective. The price of nearly $42 per barrel was a record in current dollars. But, after adjusting for inflation, oil prices are far lower than the peaks during previous crises.

In today’s dollars, oil hit a peak of around $80 per barrel in the early 1980s and gasoline sold for the equivalent of $2.85 per gallon.

Analysts are forecasting that the current peaks will not be sustained for long. So most are not worried that the spike in energy prices will feed into sustained inflation pressure.

The threat concerns wages. If Americans see their purchasing power eroded by higher energy costs over the long term, that affects what economists call people’s “inflation expectations,” and they begin to demand larger wage increases to compensate.

That happened during the 1970s and led to a debilitating wage-price spiral. It did not end until the Federal Reserve drove interest rates up to levels unseen since the Civil War, bringing on the severe 1981-82 recession that finally tamed inflation.

“Right now, the rise in energy prices hasn’t had a measurable impact on people’s views about inflation, but if prices stayed high for a long enough period, it would,” said Mark Zandi, chief economist at, a forecasting firm in West Chester, Pa.

Most analysts believe the central bank is not worried that the rise in energy prices will become embedded in overall inflation. For that reason, economists are still forecasting the Fed will start raising rates, probably at the June 29-30 meeting, but at a slow pace that will reflect moderate inflation pressures.