Lurking Oil Shock Could Wreak Havoc

The ballooning price of oil is rearing its ugly head as a potential new and dangerous economic threat.
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After reading in a local paper that he had died, a very live Mark Twain emphatically denied it, uttering that now famous quote: "The reports of my death are greatly exaggerated."

It may be the same thing can be said about our most recent recession, which, given the onset of a peppier economy, is widely believed to have gone the way of the black-and-white TV set.

Maybe so, but then again, maybe no because some economic watchers point to a developing trend that suggests another recession is lurking in the wings.

Sure, we all know the obvious recessionary dangers, such as the renewed downturn in housing, which will precipitate an accelerated rate of foreclosures, the prospects of a wave of new layoffs by financially-strapped state and local governments and the ongoing, high 9.4 percent jobless rate, which, at best, is expected to show only a minimal improvement this year.

None of these, however, ftits the bill for the new recession reason being referred to here. This one centers on an emerging risk -- the ballooning price of oil -- which is rearing its ugly head once again in the face of the Egyptian riots as a potential new and dangerous economic threat.

The facts speak for themselves. According to knowledgeable energy industry trackers, 10 of the past 11 recessions since World War II can be directly linked to oil shocks or sharply higher oil prices. The very same can be said about six of the last seven recessions since 1973.

On top of this, I recently read in a Florida newsletter, Strategic Investment, that one energy expert, Steven Kopits, the managing director of Douglas-Westwood LLC, a leading provider of business research and analysis on global energy services sectors, has shown that the U.S. economy reliably sinks into a recession when spending on oil and gasoline exceeds 4 percent of GDP, as it will do with oil at $90 a barrel.

Every driver will tell you they're getting beaten up at the gas pump in the wake of a sharply rising price per barrel of oil (now at around $89), which has more than doubled from its March-April 2009 trading range of about $40. As Oppenheimer & Co.'s well-regarded energy analyst Fadel Gheit explains it to me, every $1/a barrel rise in the price of oil is equivalent to about a $0.2 to $0.3-a gallon hike at the pump. That may not seem like a lot, but it is if you look at it on a broader scale, what with every penny boost at the pump draining an estimated $1.5 billion out of household cash flow.

So where are oil prices headed this year following a 2010 close of $91.48? Gheit figures a realistic 2011 range is between $75 and $100 a barrel, but he doesn't rule out a higher level, say between $90 and $100, due to a weaker dollar, inflation fears, the threat of global disruptions and brisk fund trading in oil, among them hedge and pension funds.

He's quick to note, though, that such price ranges are not supported by supply-demand factors, what with an abundance of available supply, most noteworthy 5 million barrels a day of spare capacity in Saudi Arabia.

Moreover, he points out, every one, thanks to research breakthroughs and research and development, is becoming more energy efficient. About 10-15 years ago, he points out, we got 10 to 15 miles a gallon, now we're getting 25 miles a gallon, and in 5-10 years it'll probably be double that. In other words, he says, we're all going to get a bigger bang for the buck.

Getting back to the risk of an oil-related recession, a number of economists see it as a real potential danger that could precipitate recessionary pressures. One of them is Madeline Schnapp, the economist at West Coast-based TrimTabs Research, who recently griped to me that it cost $75 to fill up her SUV. In her neck of the woods, she says, the average price of gas has risen from $2.90 to $3.40 a gallon, which she calculates is a $60 million tax on consumption nationally. "We're talking about an economic hardship," says. "The more you spend on energy, the less discretionary income."

Although we're right around that recession-producing $90 a barrel, Kopits, for one, doubts we'll see a recession at current oil prices, given the current phase of recovery. But he does see the high price as an economic drag by slowing the rehiring of millions unemployed here and reducing consumption.

As of now, Kopits thinks the U.S. can tolerate current prices, but he does see a "substantial risk" of a recession should oil rise to the $100-$120 range. Whether such a range could be in the cards is anybody's guess, but one could certainly view higher prices as probable, given Kopits' observations that consumption estimates for 2011 are too low by about a half, conspicuously so because of the increased demand he expects from China, an increase in this year's demand by about two million barrels a day, mostly from emerging nations, and flat overall supply.

Against this background, our Energy Information Association expects world demand to climb 1,47 million barrels per day this year to 86.65 million barrels per day, another catalyst for higher prices.

An unanswered question is the impact of the riots in Egypt on the price of oil, which has already risen somewhat on that chaotic situation. The longer it lasts the higher the price of oil will go, observes one commodities trader.

Kopits sketches a worrisome 2012, noting if the 2012 supply situation looks like 2011's, then we'll run out of capacity next year. Historically, he adds, when demand outstrips all supply, that leads to an oil shock, which, in 2012, could be similar, he believes, to the one we experienced in 2008. In July of that year, crude rose to an-all-time high of $147.27 a barrel.

If he's right -- and that's a big if -- such an oil shock could be pretty devastating. Among other things, it could well set the stage for a double-dip recession, establish a widespread price of $4 a gallon at the pump, possibly lead to some airline bankruptcies and open the door to a price of triple-digit a-barrel crude, which could be chaotic for corporate earnings, especially those of transportation companies.

What do you think? E-mail me at Dandordan@aol.com.

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