Commentary: Big Energy's Rise Is Everyone Else's Loss

By Charles J. Whalen

After more than a decade of hard times, the energy sector is riding high. In the fourth quarter of 2000, profits for fuel and utility companies jumped $7.8 billion, or 87%, above their year-earlier level (chart). Meantime, profits of nonenergy companies fell $18.5 billion, or 20%, in part because of higher fuel and electricity costs.

Beyond the obvious negative effect of higher energy prices on consumers, a sustained shift of profits to energy companies undermines a key factor in the prosperity of the 1990s--capital investment. The New Economy investment boom was fueled in part by rising profits, which helped companies spend on productivity-enhancing equipment. But "the transfer of profits has reduced the cash flows of energy-consuming companies, so investment has been cut back," says Stephen P. Brown, director of energy economics at Federal Reserve Bank of Dallas.

CASH RESERVES. Even though oil and gas companies are flush with cash, they aren't likely to offset much of the decline in capital spending in the rest of the economy. Major oil companies, such as Exxon Mobil Corp. (XOM ) and Chevron Corp. (CHV ), are expected to increase investment in exploration and production by at least 20% this year, says Tina J. Vital, an oil-and-gas equity analyst at Standard & Poor's Corp. But that will still leave them with "a ton of cash," she says. And only about 30% of that new investment is likely to occur in the U.S.

Today, more investment dollars of nonenergy companies must go to dealing with rising energy prices and potential or actual shortages, such as those California faces. That means, say, spending money on a backup generator instead of the latest computer systems. Rolling blackouts have made California companies "very concerned about the availability of energy, not just about prices," says Tapan Munroe, an energy consultant in Moraga, Calif. "There is a rise in the purchase of small turbines, batteries, and other power sources."

To some degree, this changes the focus of management from boosting productivity to cutting energy use. "All of a sudden everyone's talking about conservation and energy efficiency," says Arthur L. Smith, chairman and CEO of John S. Herold Inc., an energy consulting firm.

This new emphasis could bring slower productivity growth. Indeed, the productivity slowdown after the 1973-1974 oil price shocks is partly explained by the need to replace energy-guzzling machinery, trucks, and other capital equipment as oil and gasoline costs soared. Such energy-driven spending diverted funds from other investments.

While rising energy costs are squeezing the profit margins of most businesses, heavy energy users are getting the worst of it. The more-than-doubled price of natural gas has devastated metals and chemical companies, says Smith. "Companies in these industries have a very bleak outlook because they're going to be uncompetitive in world markets," he says.

Increased oil-company investment won't go very far in making up for the job losses in other sectors, since energy companies use fewer workers per dollar of revenue than most businesses. Moreover, investment by oil companies is very different than corporate spending elsewhere in the economy, where intense competition guarantees that consumers benefit quickly from productivity gains. By contrast, the oil market is dominated by OPEC, which has been cutting output as needed to buoy prices. That means productivity improvements benefit mainly oil-producing countries and oil companies.

In the long run, investment in oil exploration will increase supply and reduce oil prices. But as long as energy prices stay high, they are a threat to New Economy productivity.

Whalen covers the economy from New York.

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