What's the impact of high oil, gas prices on consumers and the U.S. economy?

Posted: Saturday, May 24, 2008 - 07:09:02 pm PDT
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By DANIEL PINKERTON 

Recently crude oil surged to an all-time trading high over $133, while gasoline prices, which for months lagged the big run-up in oil, suddenly accelerated quickly toward what experts fear could be $4 per gallon at the pump by the summer travel season. Few inputs impact the U.S. economy as much as the price of oil; rising prices can have negative effects on macroeconomic variables from real GDP growth, inflation and employment, to exports and imports, and interest rates. In fact, many say the recessions in the 1970s and 1980s were caused by oil price increases.

The Joint Economic Committee's recent fact sheet, High Oil Prices Have Significant Effects on Consumers and the U.S. Economy, does an exemplary job of addressing the reasons and ramifications of rising oil prices. While the report cites numerous causes for the recent rise in oil prices, including "decisions made by OPEC and other oil-producing countries, stagnant production in Iraq, and ongoing concerns about political and supply stability in a number of oil-producing countries," it asserts that it's the greatly increased demand for oil in developing countries such as China and India that likely will keep high oil prices high for the foreseeable future.

Interestingly, although American consumers have cut back on their energy use (oil demand in the United States grew by just 0.4 percent in 2007 and is expected to be flat in 2008), analysts estimate that global oil demand will increase by 1.4 million barrels a day this year. As Keith Kohl notes in his article, Don't Panic when Oil Breaks $120 a Barrel in 2008, because the fivefold increase in oil prices over the last several years hasn't lowered global demand, the simple supply/demand lesson for consumers is -- get used to higher prices.

Will these higher oil prices push the economy into recession? On the bright side, the Joint Economic Committee's report points out that many experts believe the increased energy efficiency and the changing composition of output mean that the U.S. economy is less vulnerable to high oil prices than it was during the oil crisis of the 1970s. However, a growing number of economists question whether the continuous squeeze at the pump may gradually erode the confidence of consumers already spooked by the fallout of the subprime mortgage crisis and the freefalling housing market. According to the Joint Economic Committee, hardships due to high prices of gasoline are likely to get worse as gasoline prices have increased all winter long and are certain to rise more during the summer. According to the report, last winter, U.S. gasoline prices ranged from $2.17 to $2.61 per gallon while this winter, prices ranged from $2.76 to $3.13 per gallon. Last week, the national average was $3.25, the highest recorded average since May 2007.

Crude oil also affects prices paid by households who depend on fuel oil to heat their homes. The Joint Economic Committee cites forecasts by the Energy Information Administration (EIA) which predict that crude oil increases will push average United States home heating costs 33.7 percent higher for homes heated with heating oil, 5.6 percent higher for those using natural gas, and 2.3 percent higher for those using electricity, when compared to last year's heating season.

While increasing transportation and home heating costs may have caused you to make some changes in your life, whether it's carpooling more, shortening a vacation, or putting off major purchases such as a new car or appliance, high oil prices also have a negative impact on economic growth because of their effects on producer costs. That is, as the prices of gasoline and heating oil rise, so do the prices of goods and services that use oil products. If those costs can't be passed along to the consumer, it can lead to unemployment and subsequent decreases in production. In fact, the EIA has estimated that a sustained 10 percent increase in the price of oil results in a loss of real U.S. GDP in the range of 0.05 to 0.1 percent. Assuming this EIA rule of thumb is correct, the Joint Economic Committee figures that every $10 per barrel increase in the price of oil would reduce U.S. GDP by approximately $6.9 to $13.8 billion in current dollars.

As the Joint Economic Committee correctly points out, because the cost of oil affects the cost of transportation, power generation and other products, increases in the price of oil can lead to inflation. For example, in November 2007 the Consumer Price Index for All Urban Consumers (CPI-U) rose sharply, at a seasonally adjusted annual rate of 10 percent. About 70 percent of the overall increase in the CPI-U was a result of energy price increases.

Finally, an increase in the price of oil produces a direct transfer of wealth from U.S. consumers to foreign oil producers. Even moderate changes in the price of oil can result in significant transfers. For example, the Joint Economic Committee estimates that the Iraq war has added $5 per barrel to the cost of oil. Between 2003 and 2008, this will lead to an estimated net transfer of $124 billion out of the United States.

What can you do?

Obviously, the long-term solution to high oil prices involves continued conservation, alternative energy sources, new technologies to allow more oil to be pumped out of existing reservoirs, new oil fields, hybrid vehicles, more telecommuting and stronger fuel economy standards for car manufacturers.

But, what can you do today?

• There are a number of Web sites that help you find cheap gas, but keep in mind that the distance you drive for these bargains can negate what you save. Check out GasBuddy.com (www.gasbuddy.com) and GasPriceWatch.com (www.gaspricewatch.com).

• To conserve gas, tune-up your car on a regular basis and lighten your load.

• Drive within the speed limit on the highway. Engines operate most efficiently in the 55 to 60 miles per hour range. Drive much faster and you'll use excess fuel. Quickly braking or accelerating also burns extra fuel.

• Air conditioning decreases fuel economy by 20 percent, but open windows increase drag. Accordingly, air conditioning is most efficient for faster speeds, but when you're stalled in traffic, roll down the windows.

The Consumer Energy Council of America (CECA) also provides a number of simple, low cost solutions to reduce heating bills:

• Close the fireplace damper tightly.

• Install a programmable thermostat -- one that automatically sets the temperature higher when you are awake and lower when you are sleeping or at work.

• Caulk around windows and doors.

• Tune up your heating equipment every year or two.

• In colder weather, set your thermostat back a degree or two -- for every degree lower you set your thermostat, you will save 3 percent on heating costs.

• Replace filters in the forced air systems.

• Add more insulation to the attic.

• If you have an oil heating system that's more than 10 years old, chances are you can save at least 15 percent to 20 percent on fuel consumption by upgrading to a flame retention burner. Replacing the burner is significantly cheaper than replacing the entire system and the payback could be as quick as a couple of years.

Also, because heating the water in your house represents up to 20 percent of your energy costs, the CECA recommends that you:

• Turn down the thermostat on your hot water heater to 120 degrees.

• Install a water-saving showerhead.

• Use cold water for washing clothes.

• Repair leaky faucets.

• Install a heater wrap around the hot water tank.

(Source: www.cecarf.org/aboutCECA/about.html)

Dan Pinkerton is the President of Pinkerton Retirement Specialists, a private wealth management company ranked as one of the top 100 independent advisers in the nation by Registered Rep Magazine in 2007. Securities offered through LPL Financial, Member FINRA/SIPC. Information: www.pinkertonretirement.com.