Add another item to the list of threats to the economic recovery: the price of oil.
Memories of $145-a-barrel oil and $4-a-gallon gasoline faded quickly after the last big price spike in 2008. Now they're coming back as investors -- either encouraged by the global recovery or concerned about the possible inflationary effects of the U.S. Federal Reserve's stimulus efforts -- plow money into the commodity at a record pace.
As of Friday, the price of a barrel of oil stood at $88.02, up 21% from a year earlier. A gallon of gasoline, on average, cost $3.03 in the U.S. in the week ended Dec. 13, up 14% from a year earlier. If the trend persists -- some forecasters believe the oil price will exceed $100 a barrel next year -- the resulting hit to everyone from U.S. consumers to energy-hungry Asian manufacturers could create an unwelcome drag at a delicate time for the global economy.
'As we keep climbing higher here, you start to worry,' says Ethan Harris, chief North America economist at Bank of America Merrill Lynch.
Mr. Harris notes that the mid-2008 price spike had already triggered a sharp drop in consumer spending when the bankruptcy of Lehman Brothers took center stage. He estimates that a $15 rise in the price of oil could shave about half a percentage point from U.S. economic growth in 2011, enough to wipe out the stimulative effect of the Fed's latest $600 billion round of bond-buying.
To be sure, the price of oil can also fall, and the market looks very different than it did ahead of the 2008 spike. This time around, financial investors are playing a bigger role. In the market for oil futures and options, investors such as hedge funds and exchange-traded funds have been piling into contracts that rise in value with prices. As of Dec. 7, their bullish bets exceeded their bearish bets by about 223 million barrels, the highest level on record.
In the physical market, oil producers have ample capacity to keep prices in check. The International Energy Agency estimates spare capacity among Organization of Petroleum Exporting Countries at 6.4% of global demand, nearly double the level of late 2007. As of the end of November, the world had enough oil in its inventories to cover demand for 20 days without drying out pipelines and refineries, according to data provider Oil Market Intelligence. That's up from 14 days in November 2007.
Thanks to the added inventories, 'the broader economy is now more insulated from oil shocks' than it was back in 2008, says Philip Verleger, an energy economist at the University of Calgary's Haskayne School of Business.
While many see speculative investment as a source of volatility, it might actually help prevent a spike, says Mr. Verleger. By pushing up the price of oil to be delivered in future months, investors have made it more attractive for traders to buy oil now and hold it for future sale. That, in turn, keeps inventories higher, providing a cushion that can limit price swings in the event of sudden changes in supply and demand.
If the price of oil does rise further, it won't necessarily do economic damage. For one, the price spike of 2008 led many people and companies to cut back on energy consumption, a shift that could make them more resilient to price increases this time around.
Beyond that, oil-price increases can have little to no impact if they correspond to a decrease in the value of the dollar against other currencies. Because oil is bought and sold in dollars, it doesn't become more expensive for most of the world's buyers unless the price increase exceeds the drop in the dollar. And in the U.S., the export boost from a cheaper dollar can create more jobs, offsetting the pain of higher prices at the gas pump.
Over the past four months, though, the 16% increase in the price of oil has far exceeded the 2% drop in the dollar's value against the currencies of U.S. trading partners. At the same time, energy costs are taking up a larger share of U.S. consumers' budgets, accounting for 5.5% as of October. That's up from a low of 4.8% in spring 2009 but still well below the 2008 peak of 6.9%.
Historically, energy costs have become a problem for spending when they exceed about 6% of the average consumer budget, says James Hamilton, an economist at the University of California, San Diego. 'I think we've just reached the point where it could start to matter for the economy,' he says.
In short, while there are plenty of reasons to believe oil prices shouldn't be a problem, they're getting close to becoming one.
