At $110, Oil Will Start to Hurt

(Updates with airline-capacity cut in 19th paragraph.)

March 7 (Bloomberg) — A recovering economy helped U.S. chief executive officers weather crude’s surge past the $ 100 mark. At $ 110 a barrel, the pain would start to kick in.

As oil traded at 29-month highs last week on concern that violence in Libya would further crimp Middle Eastern supplies, CEOs said they were waiting to see how much the price rises, and for how long.

“Any time something like oil goes up dramatically overnight, it becomes very hard to adequately plan,” said Samuel Allen, 57, chairman and CEO of Deere & Co., the world’s largest maker of agricultural equipment. “It has caused us to be more careful or cautious in watching the outlook, but we have still moved forward with all our plans.”

Corporate assumptions would have to start changing when oil reaches $ 110 a barrel, according to economists such as Chris Low of FTN Financial in New York. Crude at that price would offset the benefit from the tax cut approved by Congress in December, and begin to slow economic growth, Low said.

“As long as consumers are willing to pay up a little more, there really isn’t going to be a significant impact,” Low said in an interview. “But we’re pretty quickly running out of time there with oil through $ 100 a barrel. We’re getting to levels where we have to think about taking our forecasts lower.”

Oil Rises Again

Oil for April delivery rose 90 cents, or 0.9 percent, to $ 105.32 a barrel at 12:02 p.m. on the New York Mercantile Exchange. Futures touched $ 106.95, the highest intraday price since Sept. 26, 2008. That pushed the gain to 22 percent since Feb. 18, when crude began climbing as Libya’s civil strife stoked concern that energy exports elsewhere in the region might also be at risk. Brent crude, the London benchmark used to price many European and African oils, was up 1.6 percent at $ 117.81.

As manufacturers such as Deere assess how prices may affect business, consumer companies already are adapting. U.S. airlines have enacted six broad fare increases in 2011, and General Motors Co. is tightening the stock of autos in case buyers shun showrooms as they did in 2008 when gasoline peaked at $ 4.11 a gallon before the financial crisis.

“We worry about $ 100 oil all the time,” Vice Chairman Stephen Girsky said in an interview. “We’re war-gaming that all the time. Part of the strategy is to keep inventories low.”

GM’s supply of 517,000 vehicles at the end of February represented about 2.5 months of deliveries, compared with about 2.9 months’ worth a year earlier at the Detroit-based automaker. The clampdown came amid industrywide sales running at the fastest annual pace since 2009.

Gasoline’s Rise

Consumers’ response to costlier gasoline is pivotal because they account for about 70 percent of the U.S. economy and feel oil-market disruptions with every fill-up, economists said. At $ 3.51 a gallon yesterday in a survey by Heathrow, Florida-based motorist group AAA, the average U.S. retail price for regular unleaded gasoline has risen about 14 percent this year.

The duration of higher prices will determine how consumers react, said Daniel Yergin, chairman of IHS-Cambridge Energy Research Associates Inc. in Cambridge, Massachusetts, and author of the 1991 oil-industry history “The Prize: The Epic Quest for Oil, Money and Power.”

“If it’s a short term, then take it in stride,” Yergin said in an interview. “If it’s longer term, if it extends out weeks or months, then it really becomes a very big question mark for economic recovery.”

‘Main Conduit’

A $ 10-a-barrel increase in crude would “reduce growth by somewhere between 0.2 to 0.3 percentage points per year in each of the next two years,” said Drew Matus, senior economist at UBS Securities LLC in New York. “It’s basically an overall impact on the economy, but obviously the main conduit through which it would act would be the U.S. consumer.”

While that kind of drag wouldn’t come close to pushing the U.S. back into a recession, it would slow the rebound from the worst economic slump since the Great Depression. For 2010, the world’s largest economy expanded 2.8 percent, the most in five years, after shrinking 2.6 percent in 2009.

Oil at $ 125 would be “really a crucial tipping point,” pushing gasoline to $ 4 a gallon, said Carl Riccadonna, senior U.S. economist at Deutsche Bank Securities Inc. in New York.

“That would be the level where we start to significantly downgrade our economic projections,” Riccadonna said, including a 50 percent slash in his forecast for growth of about 3.1 percent in household consumption.

‘Stall Speed’

“Suddenly we’re looking at GDP right around 2 percent,” he said in an interview. “At that 2 percent level on GDP, we’re very close to stall speed on the economy.”

Some pullbacks are under way. American Airlines parent AMR Corp. and Delta Air Lines Inc. are trimming planned growth in seating capacity to blunt fuel expenses, even with the boost from more fare increases this year than in all of 2010.

Frontier Airlines, a unit of Indianapolis-based Republic Airways Holdings Inc., joined that effort today, saying second- quarter seating capacity would be unchanged from a year earlier after forecasting growth of as much as 2.5 percent. Greg Aretakis, vice president of revenue production, cited the “uncertainty” of future oil prices.

“Rising gas prices and still-high unemployment levels weigh on the minds of our customers,” Bill Simon, CEO of U.S. operations for Wal-Mart Stores Inc., said on a conference call on Feb. 22. “These issues affect discretionary spending and figure into our assessment for guidance.”

The Bentonville, Arkansas-based retailer has posted seven straight quarters of declining same-store sales in the U.S., and it forecast a drop in such revenue this quarter of as much as 2 percent from a year earlier.

Boyd Gaming Corp. expects that gamblers eventually may need some reassurance to help overcome any reluctance to pay more to drive to one of the Las Vegas-based company’s casinos.

‘Psychological Aspects’

“I’m sure you’ll start to see promotions around gasoline and other things as part of a marketing campaign,” Chief Operating Officer Paul Chakmak told analysts on a conference call on March 1. “People are generally fairly resilient, other than the psychological aspects of it.”

Pump prices in some states are approaching the $ 4-a-gallon mark, topped by the $ 3.90 average in California and $ 3.88 in Hawaii through yesterday, according to AAA’s website. Retail diesel fuel climbed to $ 3.88 a gallon, up 17 percent this year, according to AAA.

‘Near-Term Concern’

“Our near-term concern is more for our customers,” Deere’s Allen said in an interview. The product lineup at Moline, Illinois-based Deere includes lawnmowers, grain harvesters and construction equipment, some running on gasoline and others on diesel fuel.

For Boise Inc., a maker of paper and packaging, each 50- cent increase in diesel fuel means the loss of $ 8 million in earnings before interest, taxes, depreciation and amortization, Chief Financial Officer Samuel Cotterell said.

While the Boise, Idaho-based company doesn’t build fuel surcharges into contracts, it may be able to pass along some costs, Cotterell told analysts on a March 2 conference call.

Recent indicators suggest that the economy has been strong enough to handle the march toward $ 100 oil that began last month. The Bloomberg Consumer Comfort Index, formerly the ABC News U.S. Weekly Consumer Comfort Index, was minus 39.3 in the period to Feb. 27, little changed from the minus 39.2 reading the prior week that was the highest in almost three years.

Joblessness fell to 8.9 percent last month, and employment climbed by 192,000, the Labor Department reported on March 4.

Growth in payrolls and income should shield the nonfuel spending crucial to the economy, said Frank Badillo, a Columbus, Ohio-based senior economist for Kantar Retail.

No Decline

“We won’t see a falloff in nonfuel spending,” Badillo said in an interview. “It will be affected, but it’s not like we are going to see huge declines. They are going to continue to spend more, it just may not be as much more.”

Oil supplies in Saudi Arabia also are sufficient to ensure that oil at $ 120 or even $ 150 a barrel from disruptions elsewhere in the Middle East would only be a “blip up” that wouldn’t last long, said Nayantara Hensel, the U.S. Navy’s chief economist.

“Oil prices would need to exceed $ 125 per barrel for more than four months to substantively limit economic growth,” she said in an interview.

Like Deere, manufacturers such as Caterpillar Inc., the world’s largest maker of construction equipment, haven’t made any changes yet to investment decisions in response to the jump in crude.

“We take a long-term view,” said Jim Dugan, a spokesman for Peoria, Illinois-based Caterpillar. “The prices of various commodities are a small piece of that.”

Drill-Bit Parts

At Dover Corp., about a quarter of annual revenue comes from the oil and gas industry, where rising demand for equipment such as drill-bit parts buoys results. About the same amount is tied indirectly to consumer spending, because the Downers Grove, Illinois-based company also makes refrigerated display cases.

“For us, the increase in oil isn’t any different than the increase in steel, or nickel or copper or, goodness gracious, even the increasing cost of health care,” CEO Robert Livingston said in an interview. “When we can’t cover it with productivity initiatives, yes, we do pass it on to customers.”

Manufacturers tend to absorb energy-cost increases as long as they’re confident that the new levels are only temporary, because they don’t want to change their prices too often, according to FTN Financial’s Low. Unlike price surges triggered by market speculation, which tend to fade more quickly, oil- market fallout from the Libyan crisis may not end soon, he said.

“We’re talking about revolution that has spread across borders that is, if anything, getting hotter over time,” Low said. “It will likely be many months before the situation in the Middle East has calmed down.”

–With assistance from Alexander Kowalski in Washington, Shruti Singh in Chicago, Mark Clothier in Detroit, Cornelius Rahn in Frankfurt, Andreas Cremer in Berlin, Laurence Frost in Paris, Tommaso Ebhardt in Milan, Joanna Starritt, Ryan Chilcote, Grant Smith and Rachel Graham in London, Margot Habiby, Mary Schlangenstein, Michael Lee and Ed Dufner in Dallas, Rachel Layne in Boston, Thomas Black in Monterrey, Mark Shenk, Jim Polson, Matthew Boyle and Julie Alnwick in New York and David Wethe, Edward Klump and Bradley Olson in Houston. Editors: Ed Dufner, Jeffrey Tannenbaum

To contact the reporter on this story: Will Daley in New York at [email protected]

To contact the editor responsible for this story: Ed Dufner at [email protected]

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