News: Analysis & Commentary
LIVING IN A WORLD OF CHEAP OIL
Ultra-low prices are a boon for business--and just about everybody
Consider it a surprise birthday gift to the economy as the 1990s expansion enters its eighth year. Over the last six months the price of crude oil has plunged from $22 a barrel to a low of $12.91 a barrel on Mar. 17, a level not seen since October, 1988. And the prices of gasoline, electricity, and anything else produced with petroleum are headed down: Energy prices nationwide fell 2.4% in the first month of this year and are down 25% in the 12 months ended in January. In some cities, gasoline has fallen below 80 cents a gallon.
This year's stunning and unexpected decline in energy costs is causing corporate planners to rip up their budgets. At current prices, Continental Airlines could save up to $140 million on jet fuel this year, American Airlines says it spent $50 million less in the first quarter alone, and Tenneco expects to spend $4 less a ton to produce container board--and these cost declines drop straight to the bottom line.
What's more, the falling energy costs provide fuel for more economic growth. Because consumers are spending less on fuel and heating, they have more money to spend on other goods such as food, entertainment, and cars. And with falling energy costs holding down inflation, the Fed has another reason not to apply the brakes with interest-rate hikes. "This almost offsets the effects of the Asian crisis on U.S. economic growth," says David A. Wyss, chief economist at consultants Standard & Poor's DRI. Indeed, falling oil prices could add four-tenths of a percentage point to growth in 1998.
To be sure, oil prices could pop back up again. The biggest dangers are political disruptions of the oil supply--most likely surrounding the situation in Iraq--or a sudden agreement among oil suppliers to cut production. Venezuela sent oil prices up a tick on Mar. 18 from their lows when it announced that it will attend OPEC's Mar. 30 meeting. That leaves some oil consumers waiting--hopefully--to see if the low prices stick. "If this continues for more than several months, we'd probably get more excited," says Continental Chief Financial Officer Lawrence W. Kellner.
But even skeptics accept that oil has moved into a lower trading range. For example, in January, when oil fell below $17, Nizam Sharief, director of research at energy risk managers Hornsby & Co., predicted that crude would quickly return to a trading range of $17 to $21 a barrel. But Sharief--indeed most oil analysts--now see more forces holding prices down, to $10 to $15 a barrel, even after this mild, El Nino-driven winter turns to a hot summer. Oil consultant Purvin & Gertz Inc. say it won't be until 2000 before oil averages $17 again.
Why? It looks more likely Asia will take years to resume its prior growth rates and appetite for oil. Giant oil discoveries in the Caspian Sea region, offshore West Africa, and in the Gulf of Mexico's deep waters promise new sources of non-OPEC oil (page 54). Finally, the Organization of Petroleum Exporting Countries no longer has the ability to tightly control pumping by its members. Perhaps most important, oil now is cheaper to find and retrieve, thanks to new exploration and production technol-ogies, such as directional drilling. "There is chronic excess capacity for as far as we can see--up to 2005," says Leo P. Drollas, deputy director at the Centre for Global Energy Studies, London-based oil watchers.
As corporate budgeters start plugging those numbers into their spreadsheets, they see the glimmer of a new dawn. Big chemical manufacturers are predicting that raw materials used in everything from plastics to drugs will fall 1.3% this year--the first time all decade. In the past 12 months, jet fuel prices are off 27%. And, in real terms, the $1 a gallon U.S. consumers pay on average for gas is the lowest price in recorded history, according to the American Petroleum Institute.
"We're just beginning to assess what this will do," says Jerry Lowe, a vice-president and general manager at Tenneco Packaging. Beyond the savings in its container-board manufacturing, Lowe sees oil savings augmented by electric deregulation. Tenneco, which now generates half the power to run its paper mills, is considering reducing its energy assets. "We want to make money in products, not energy plants," says Lowe.
Of course, falling prices affect industries differently. Oil companies such as Amerada Hess, Murphy Oil, and Unocal are reducing spending in anticipation of lower profits. Shares of the major oil-field service companies have tumbled, taking down the Standard & Poor's well equipment and services index 23% since Nov. 5. Small carmakers aren't seeing any benefit, either. "When you can buy a gallon of gas for less than it costs to buy a liter of bottled water, there aren't a lot of natural incentives to buy a small car," says Donald W. Hudler, president of General Motor's Saturn Corp.
"MINI-TAX CUT." On the other hand, Detroit is selling lots of gas-hungry trucks and sport-utility vehicles. Falling gasoline prices "represent a minitax cut for consumers and provide our buyers with extra resources" to spend on their vehicles, says Ford Motor Co. senior economist Ellen Hughes-Cromwick.
Businesses could see a double payoff by continuing to push for energy efficiency. Unlike consumers, who can be expected to drive their Ford Expeditions more this summer, corporations have regulatory reasons to continue efficiency efforts. And many are able to chop manufacturing and processing costs while reducing energy demands. "There seems to be a sense it's energy's time," says Charles L. Watkins, president of Duke Energy's retail-services business. "The first thing I'm asked is, `how can you save me 20%?' There's an assumption that prices will be falling."
Most oil companies seem to understand the new realities of the marketplace. Even at $15 a barrel, oil companies can thrive, thanks to years of cost-cutting. "We've structured ourselves to exist in that type of an environment," says Phillips Petroleum Co. chief economist Alan H. Struth.
Now, other businesses are beginning to wake up to what the oil companies already knew. Barring political upheavals, crude prices seem likely to stay low--and that's good news for corporations and the U.S. economy.By Gary McWilliams in Houston, with bureau reportsReturn to top