$50 Oil: A Spreading Slick of Pain

With crude prices finally crossing that line, and promising to stay lofty, here's how it affects the economy -- and you

By Amey Stone

The long-anticipated moment finally arrived -- oil reached $50 a barrel. Light, sweet crude that's traded on the New York Mercantile Exchange had previously peaked at $49 in mid-August before falling back to around $44 through the first half of September. But when Hurricane Ivan roared through the Gulf of Mexico and new worries about production in Venezuela and Nigeria cropped up, oil marched back up and on Sept. 28 crossed into $50 territory.

Brace yourself. Even if crude slips back from the $50 milestone (light, sweet crude for November delivery closed at $49.51 on Sept. 29), high-priced oil isn't going away. And the pain in your pocketbook may be just starting.

The problem isn't just higher gasoline prices -- although that's where consumers have felt the impact first. Oil's jump affects the entire U.S. economy and has already contributed to a summer slowdown in growth, a weaker-than-hoped-for job market, and a slide in consumer confidence. Eventually, if companies pass along higher energy costs, pricier oil could lead to inflation, although that hasn't happened yet.

Depressing as it is, when you take a broad view of the problem you see the many ways costlier energy can cut into your cash flow -- even if you haven't suffered much from higher prices at the gas pump. Here's how $50 crude could hit you in your pocketbook:

Higher Gasoline Prices. As the last few months have shown, prices at the pump don't move in lockstep with crude. Thankfully, that meant gas prices didn't keep rising in July and August as crude peaked. Instead, gasoline hit its high in May at a national average of $2.05 a gallon for regular unleaded, according to AAA's Fuel Gauge Report. As gasoline inventories rose during the summer, the national average price fell back to around $1.85 until recently. But it renewed its ascent recently on the current oil spike.

The Energy Information Administration (EIA) predicted in a Sept. 8 report that prices would fall as low $1.80 by yearend, thanks to high inventories of gasoline. But many experts don't believe it. Mark Baxter, director of the Maguire Energy Institute at SMU's Cox School of Business in Dallas, thinks gas will climb to $2.10 or $2.15 a gallon. That compares to a 2003 average price of $1.57 and a 2002 average of $1.40. "I still believe it will head north another 20 to 25 cents," he says. "That would truly reflect crude at $50 barrel."

For a family that drives two cars approximately 15,000 miles a year, that would amount to an extra $650 or so in gasoline costs in 2004, vs. those for 2003. Many families are hit much harder, for example, if they drive long distances for work or have old or gas-guzzling vehicles, points out Susan Fulton, a principal of investment-management firm WealthTrust in Bethesda, Md. She believes lower-income families are disproportionately hurt while upper-income Americans may hardly feel the pinch. "That is the terrible truth of it," Fulton says.

Costlier Home-Heating Oil. Gasoline isn't the only crude oil derivative purchased by many Americans. The EIA forecasts that the average price for a gallon of home heating oil will rise to $1.50 from $1.36, for a total average expenditure of $1,048, up from $991 last year. An extra $57 isn't much of a hardship, but if the winter is particularly cold or you have a large, drafty house, expect a price increase a much steeper hit. By Amey Stone More Expensive Transportation. Transportation companies are often the first to try to pass along higher fuel costs to customers. Consider that jet-fuel and diesel-fuel (used by truckers) prices have gone up sharply this year. Not only will it cost more for airlines more to fly their planes but all businesses will pay more to move their products to stores, too.

The good news for consumers is that so far companies haven't been able to pass along too much of their cost increases. For example, even though jet fuel is up 40% in the past year, the average airline ticket is down 3.5%, says David Kelly, Putnam Investment's economic adviser. But airlines have recently imposed surcharges on customers who fail to buy tickets online. This is one way they're already trying to pass along increased costs, says Baxter.

Broad-Based Inflation? It hasn't shown up yet -- as confirmed by the negligible rise in core consumer prices in July and August. But it certainly did in the 1970s, and economic history has a knack of repeating itself fairly reliably.

Kelly reasons that when oil prices rose in the '70s it led to greater wage pressures than workers can exert now, which stimulated steep price inflation. This year, however, hourly wage increases remain below the level of inflation, which means companies can't push through consumer price increases without the risk losing business. Asked if he thinks oil is contributing to inflation, Kelly's answer: "I've got a pretty emphatic 'no' on that."

But Baxter points out that many companies will pass along higher costs when they see an opportunity, and he cites other areas that can be affected. Along with transportation costs, he points out that everything plastic is made from petrochemicals. "There we're talking just about anything not made of wood or steel," adds Baxter.

A Weaker Job Market. The Federal Reserve Board blamed the economy's summer slowdown on higher oil prices. Weak retail sales was one of its clearest manifestations. Basically, if families have to spend more on gas to get to work, that's less money left over to buy goods at WalMart (WMT ).

Gimpier growth means fewer jobs created and fewer opportunities for workers to trade up to higher-paid positions. "I don't think oil is particularly inflationary, but it is a drag on growth," says Kelly.

Lower Stock Prices. Even though wealthy Americans aren't suffering too much from higher gasoline prices, they've already felt the blow of lower equity values due to costly oil. The shocks of crude veering upward contributed to some major stock market swings this summer. Also, if companies can't pass higher costs onto consumers, this influences profits and ultimately affects valuations.

Plus, due to lower summer sales, the share prices of consumer-product companies and discount retailers are already suffering. "I don't see a lot of real retail opportunity right now," says Fulton. "The reality is the vast majority of Americans are middle- or lower-income, and they consume most of the stuff -- and they're really being creamed by higher gas prices."

Another possible market impact: If higher crude prices eventually spark inflation, that, too, would crimp share prices since the Fed would likely raise interest rates further to keep inflation at bay. Thus begins what economists like to call a vicious cycle. More expensive oil is already hitting Americans, rich or poor, in the pocketbook directly or indirectly -- and it may well continue to do so in the months to come, in ways that go well beyond the gas pump.

Editor's Note: This is an updated version of a story that originally appeared on Sept. 13.

Stone is a senior writer for BusinessWeek Online in New York

Edited by Beth Belton