Rising oil prices could strangle recovery

A recovering economy helped U.S. chief executive officers weather crude's surge past the $100 mark. At $110 a barrel, the pain would start to kick in.

Oil for April delivery rose 1.9 percent to $106.42 a barrel in New York Monday, the highest since Sept. 26, 2008. Brent crude, the London benchmark used to price many European and African oils, was up 1.6 percent at $117.81.

As oil traded at 29-month highs last week on concern that violence in Libya would further crimp Middle Eastern supplies, CEOs said they were waiting to see how much the price rises, and for how long.

"Any time something like oil goes up dramatically overnight, it becomes very hard to adequately plan," said Samuel Allen, 57, chairman and CEO of Deere & Co., the world's largest maker of agricultural equipment. "It has caused us to be more careful or cautious in watching the outlook, but we have still moved forward with all our plans."

Corporate assumptions would have to start changing when oil reaches $110 a barrel, according to economists such as Chris Low of FTN Financial in New York. Crude at that price would offset the benefit from the tax cut approved by Congress in December, and begin to slow economic growth, Low said.

"As long as consumers are willing to pay up a little more, there really isn't going to be a significant impact," Low said in an interview. "But we're pretty quickly running out of time there with oil through $100 a barrel. We're getting to levels where we have to think about taking our forecasts lower."

OIL RISES AGAIN

As manufacturers such as Deere assess how prices may affect business, consumer companies already are adapting. U.S. airlines have enacted six broad fare increases in 2011, and General Motors Co. is tightening the stock of autos in case buyers shun showrooms as they did in 2008 when gasoline peaked at $4.11 a gallon before the financial crisis.

"We worry about $100 oil all the time," Vice Chairman Stephen Girsky said in an interview. "We're war-gaming that all the time. Part of the strategy is to keep inventories low."

Consumers' response to costlier gasoline is pivotal because they account for about 70 percent of the U.S. economy and feel oil-market disruptions with every fill-up, economists said. At $3.51 a gallon Sunday in a survey by Heathrow, Florida-based motorist group AAA, the average U.S. retail price for regular unleaded gasoline has risen about 14 percent this year.

The duration of higher prices will determine how consumers react, said Daniel Yergin, chairman of IHS-Cambridge Energy Research Associates Inc. in Cambridge, Massachusetts, and author of the 1991 oil-industry history "The Prize: The Epic Quest for Oil, Money and Power."

"If it's a short term, then take it in stride," Yergin said in an interview. "If it's longer term, if it extends out weeks or months, then it really becomes a very big question mark for economic recovery."

'MAIN CONDUIT'

A $10-a-barrel increase in crude would "reduce growth by somewhere between 0.2 to 0.3 percentage points per year in each of the next two years," said Drew Matus, senior economist at UBS Securities LLC in New York. "It's basically an overall impact on the economy, but obviously the main conduit through which it would act would be the U.S. consumer."

While that kind of drag wouldn't come close to pushing the U.S. back into a recession, it would slow the rebound from the worst economic slump since the Great Depression. For 2010, the world's largest economy expanded 2.8 percent, the most in five years, after shrinking 2.6 percent in 2009.

Oil at $125 would be "really a crucial tipping point," pushing gasoline to $4 a gallon, said Carl Riccadonna, senior U.S. economist at Deutsche Bank Securities Inc. in New York.

"That would be the level where we start to significantly downgrade our economic projections," Riccadonna said, including a 50 percent slash in his forecast for growth of about 3.1 percent in household consumption.

"Suddenly we're looking at GDP right around 2 percent," he said in an interview. "At that 2 percent level on GDP, we're very close to stall speed on the economy."

Some pullbacks are under way. American Airlines parent AMR Corp. and Delta Air Line, the dominant carrier serving Minnesota. are trimming planned growth in seating capacity to blunt fuel expenses, even with the boost from more fare increases this year than in all of 2010.

"Rising gas prices and still-high unemployment levels weigh on the minds of our customers," Bill Simon, CEO of U.S. operations for Wal-Mart Stores Inc., said on a conference call on Feb. 22. "These issues affect discretionary spending and figure into our assessment for guidance."

The Bentonville, Arkansas-based retailer has posted seven straight quarters of declining same-store sales in the U.S., and it forecast a drop in such revenue this quarter of as much as 2 percent from a year earlier.

"Our near-term concern is more for our customers," Deere's Allen said in an interview. The product lineup at Moline, Illinois-based Deere includes lawnmowers, grain harvesters and construction equipment, some running on gasoline and others on diesel fuel.

For Boise Inc., a maker of paper and packaging, each 50- cent increase in diesel fuel means the loss of $8 million in earnings before interest, taxes, depreciation and amortization, Chief Financial Officer Samuel Cotterell said.

While the Boise, Idaho-based company doesn't build fuel surcharges into contracts, it may be able to pass along some costs, Cotterell told analysts on a March 2 conference call.

JOB GROWTH

Recent indicators suggest that the economy has been strong enough to handle the march toward $100 oil that began last month.

Joblessness fell to 8.9 percent last month, and employment climbed by 192,000, the Labor Department reported on March 4.

Growth in payrolls and income should shield the nonfuel spending that's crucial to the economy, said Frank Badillo, a Columbus, Ohio-based senior economist for Kantar Retail.

"We won't see a falloff in nonfuel spending," Badillo said in an interview. "It will be affected, but it's not like we are going to see huge declines. They are going to continue to spend more, it just may not be as much more."

Oil supplies in Saudi Arabia also are sufficient to ensure that oil at $120 or even $150 a barrel from disruptions elsewhere in the Middle East would only be a "blip up" that wouldn't last long, said Nayantara Hensel, the U.S. Navy's chief economist.

"Oil prices would need to exceed $125 per barrel for more than four months to substantively limit economic growth," she said in an interview.

Like Deere, manufacturers such as Caterpillar Inc., the world's largest maker of construction equipment, haven't made any changes yet to investment decisions in response to the jump in crude.

"We take a long-term view," said Jim Dugan, a spokesman for Peoria, Illinois-based Caterpillar. "The prices of various commodities are a small piece of that."

Manufacturers tend to absorb energy-cost increases as long as they're confident that the new levels are only temporary, because they don't want to change their prices too often, according to FTN Financial's Low. Unlike price surges triggered by market speculation, which tend to fade more quickly, oil- market fallout from the Libyan crisis may not end soon, he said.

"We're talking about revolution that has spread across borders that is, if anything, getting hotter over time," Low said. "It will likely be many months before the situation in the Middle East has calmed down."