Is the Energy Crisis Suddenly Over?

Maybe not, but falling prices could save the second half

There's no lack of culprits for America's economic malaise. Corporate investment has collapsed, stock prices are down, and profits are melting away. But there's one factor that Federal Reserve Chairman Alan Greenspan, for one, feels has been overlooked: soaring energy prices. Months of expensive oil and gas have taken cash out of consumers' pockets and eaten into corporate earnings, socking economic growth.

Now, relief is here. Prices of natural gas, gasoline, and crude oil are slumping in response to ebbing global demand and stepped-up output by producers. If prices stay down--and many energy specialists think they will--that should help turn the much-hoped-for second-half recovery into reality. "It's a tonic for growth," says Morgan Stanley Dean Witter & Co. chief economist Richard B. Berner, who estimates that lower energy costs could raise gross domestic product by 0.3 of a percentage point over the next year. That may not sound like much, but it's a big improvement from the 1 percentage point drag energy prices had on the economy in 2000.

Falling energy prices give the economy a double-barreled boost. With consumers shelling out less to fill up their cars, they have more to spend on everything from washing machines to back-to-school items. Economists compare the effects of falling energy prices on consumption to a tax cut that raises disposable income and buoys consumer confidence. And for corporations, lower energy prices cut the cost of raw materials and transportation. A $5-per-barrel drop in oil prices boosts profits for nonenergy, nonfinancial companies by more than 2 percentage points over a year, says Mark M. Zandi, chief economist at West Chester (Pa.) consulting firm Inc.

ACROSS THE BOARD. The drop didn't come a moment too soon. The National Association of Manufacturers (NAM) estimates that last year's price spikes took a $115 billion bite out of GDP. Greenspan calculates that one-quarter of the rise in fourth-quarter costs for nonfinancial, nonenergy companies can be directly blamed on energy prices. And Macroeconomic Advisers, a St. Louis-based economic consulting firm, estimates that rising energy costs cut real personal disposable income by three-quarters of a percentage point from July, 1999, through February, 2001.

It's across-the-board relief: Natural gas averaged about $3.55 per million BTU in June, down sharply from a high of close to $9 in January. Oil has slumped 5% this year, to an average $28.88 a barrel, according to Platts Group, which, like BusinessWeek, is a unit of The McGraw-Hill Companies. And gasoline is down to $1.474 a gallon in the week ended July 2--14% below its May 14 record of $1.713 and 15 cents less than a year ago.

A growing number of companies are already benefiting. In the closing months of 2000, Norfolk Southern Corp. (NSC ), one of the nation's largest freight railroads, was paying 45% more for diesel fuel than it had the previous year. The situation improved dramatically in the first quarter of 2001, as the Norfolk (Va.) company's diesel expenses were barely changed from a year earlier. The result: Expenses as a proportion of revenues--a key barometer of profitability for the industry--fell to 86.7% in the first quarter from 88.2% in the fourth and close to 91% a year earlier.

Other transportation companies should make out as well. Northwest Airlines Corp. (NWAC ), for instance, is now paying 70 cents per gallon for jet fuel--a dime less than it did a month ago, when prices peaked. Over a year, that differential could amount to a $200 million savings. Multiply that across the entire industry, and that's a big shot in the arm for airline profits.

Cheaper energy should provide a boost for companies suffering a profit squeeze, too. Diversified manufacturer 3M, which warned on July 2 that second-quarter earnings would not match expectations, is hoping that lower energy costs will help its bottom line in coming months. The St. Paul (Minn.) company, which makes Post-it Notes and 50,000 other products, saw its fuel bill balloon by some $13 million in the second quarter from a year ago. But thanks to falling natural-gas prices, 3M expects third-quarter fuel costs to be no higher than a year earlier.

Besides cutting corporate costs, lower energy prices are also boosting consumer spending. Paul Ballew, chief market analyst for General Motors Corp. (GM ), says the combined effect of low interest rates, falling fuel prices, and auto rebates have kept vehicle sales strong. As energy prices rose during the last year and the economy slowed, Family Dollar Stores Inc. (FDO ) responded by stocking up on such cheap, low-margin goods as paper towels and detergent in a bid to keep sales up. Now, it's looking forward to cheaper energy and federal tax cuts boosting disposable income. "We expect consumers will buy not only consumables but more apparel, giftware, artificial flowers, and other higher-margin products," says George Mahoney, executive vice-president of the Matthews (N.C.) discount-store chain.

That alone won't snap the economy out of its doldrums. But coupled with lower interest rates from Greenspan & Co. and a tax refund from Uncle Sam, it might just do the trick.

By Laura Cohn in Washington, with Rich Miller in Washington, Michael Arndt in Chicago, David Welch in Detroit, and Aixa M. Pascual in Atlanta

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