Oil heads toward US$70

Potenially grave consequences for global economy

Brad Foss
Canadian Press
Saturday, April 01, 2006

WASHINGTON (AP) - Oil prices appear headed back toward $70 US a barrel, a level not seen since hurricane Katrina battered the Gulf of Mexico coast and sporadic shortages sent gasoline at the pump above $3 a gallon U.S.-wide.

While last summer's price spike triggered outrage in the U.S. Congress and hurt sport utility vehicle sales, it caused only a hiccup in motor-fuel consumption. And for now, with demand back on the rise, the economy seems capable of absorbing uncomfortably high prices.

Analysts warn, however, that consumers and businesses could be just one major supply disruption away from more serious financial consequences.

Sherry Cooper, chief economist at BMO Nesbitt Burns, said the ramifications of $70 oil and $3-a-gallon gasoline would be "more mild" the second time around "because we're getting kind of used to it."

But while the gas-price sticker shock may be wearing off, Nomura Securities chief economist David Resler fears a more subtle fuel-related angst settling in among consumers.

"There is the pessimistic notion that this is not going to go away and that's going to have a more lasting impact on driving habits and behaviour, I suspect, than we've seen so far," Resler said.

In that context, a hypothetical supply disruption that jolts oil prices to $80 or higher and keeps them there for an extended period - say, three months - could result in "a substantial falloff in discretionary spending" that snowballs into a serious slowdown.

Perhaps the top threat for the oil market is the standoff between the United Nations and Iran, OPEC's No. 2 producer, over Tehran's nuclear energy ambitions. Iran's foreign minister said Friday his country would not use oil as an economic weapon, and that helped ease prices, but analysts say they remain concerned about supplies from Iraq, Russia, Venezuela and other places.

Unrest in Nigeria has taken more than 500,000 barrels per day of oil off the market, and more than 300,000 barrels per day of Gulf of Mexico output remains shut-in because of damage from last fall's hurricanes.

With global oil demand expected to average 85 million barrels per day in 2006, [Note: Canada's daily oil production is about 2.5 million barrels per day, British Columbia's annual oil production is a mere 14 million barrels.] and excess production capacity limited to two million barrels per day, oil analyst Jamal Qureshi of PFC Energy in Washington said prices aren't likely to retreat anytime soon.

"The market is awakening to the scope of the risks," said Antoine Halff, director of global energy Fimat USA in New York.

Yet in spite of all the apprehension about oil supplies - or maybe because of it - U.S. inventories of crude are at a seven-year high of roughly 341 million barrels. That does not include the 685,700 barrels in the country's strategic reserve, available in an emergency.

Some analysts point to this buildup of inventories as evidence the market is divorced from reality. IFR Energy Services' Tim Evans sees a "dangerous complacency about the downside potential for prices" - but many more say it is a reflection of unease about geopolitical uncertainties.

On Friday, light crude for May delivery settled at $66.63 a barrel, down 52 cents on the New York Mercantile Exchange. U.S. retail gasoline prices averaged $2.53 a gallon, or 37 cents higher than last year, according to Oil Price Information Service.

The potential exists for $3-a-gallon gasoline at some point this summer, analysts say, but that assumes out-of-the-ordinary disruptions to refining or distribution, or both. The Energy Department, meanwhile, is forecasting an average summertime price of $2.50.

Economists and oil-market experts say industry and homeowners may not like paying more for fuel but they are adapting, in large part because energy is a tiny piece of overall spending and, thanks to more efficient technology, an even smaller piece than it was during the energy crises of the 1970s.

The burden is most severe on low-income families and fuel-intensive businesses, though truckers, chemical manufacturers and, to a lesser extent, airlines have had success in passing along these costs.

Relatively low interest rates, which have made it easy to borrow money while helping to prop up the stock and housing markets, have reduced the impact of high oil prices on the economy.

© The Canadian Press 2006