Limiting Damage from Higher Oil Prices
There are isolated pockets of industrial pain, of course. Some big industries, like airlines and automobiles, are being badly pinched by soaring fuel prices. And even companies that have successfully insulated their bottom lines from added fuel costs will inevitably face depressed sales as their customers grapple with rising costs of fuel.
"If fuel prices stay high long enough to slow the economy," warned William D. Zollars, chairman of the Yellow Roadway Corporation, the country's largest trucking company, "then our customers will be making fewer goods to ship."
Apparently that is not happening yet. Many corporations have long since put in flexible furnaces that can switch between coal liquids and oil on short notice. And unlike past oil shocks, this one comes when a robust economy is enabling many companies to pass along price increases.
Even many chemical companies that use oil and gas as raw materials as well as fuel, say their customers are accepting price rises - albeit "not happily, but grudgingly," as Jeffrey M. Lipton, chief executive of the Nova Chemicals Corporation, put it.
But gasoline is generally a heftier part of consumer budgets than of business budgets. William C. Dudley, chief United States economist at Goldman Sachs, expects that two-thirds of the rising oil bill will be absorbed by consumers. "If the higher prices stick for a year," he warned, "consumers may have to absorb a $50 billion shock."
The chief executive of Wal-Mart Stores, H. Lee Scott Jr., recently estimated that increasing gasoline prices would cost its shoppers an extra $7 a week. Economists say even that slight an amount can dampen total consumer spending.
"Oil companies may not spend their extra profits immediately, but when consumers pay more for gas, they spend less for movie tickets," said Ian Sheperdson, chief United States economist at High Frequency Economics.
Lakshman Achuthan, managing director of the Economic Cycle Research Institute, warns that higher oil prices could set off the Katona Effect, in which price volatility in one item can cause consumers to pull back on all spending, even if their budgets can absorb a hit.
Still, most economists expect that continuing increases in employment will put money in enough new pockets to make up the slack. And, as William H. Steele, a household products analyst with Banc of America Securities, put it, "In good times and bad, people continue to buy toothpaste."
Even more important for the economy as a whole, sales of products and services to other companies - the so-called business-to-business sector of the economy - are growing even as sales to consumers slack off.
"Consumer spending got the economic relay race off to a good start, and now the consumer is passing the baton to business," Mr. Achuthan said. "We are in a fairly sweet spot in the economy, the leading economic indicators are strong, so I don't think business will drop the baton."
That is cold comfort to industries that are suffering now. Sales of sport utility vehicles, one of the few vehicle categories in which Detroit still dominates, have already leveled off, and high gas prices could further tarnish their appeal. Airlines, many of which have been losing money, may be thrown back into red ink if sluggish demand and competition from low-cost airlines continues to prevent the major carriers from passing on fuel costs.
"The increased fuel costs have obviously made 2004 more challenging than we originally thought it was going to be," said Frederic F. Brace, the chief financial officer of United Airlines, which recently predicted that its fuel costs will be $450 million more than expected this year.
United is not alone. Earlier this year, the Montreal-based International Air Transport Association, to which most airlines belong, predicted that the industry would turn a $3 billion profit in 2004. But fuel represents, on average, 16 percent of the operating costs of an airline, and that prediction was based on an average of $30 a barrel for oil.
"If it averages $32, the industry will break even, and if it averages $36 or more, we will definitely show a loss," said Giovanni Bisignani, director general of the trade group.
Indeed, even airlines that have long-term contracts for fuel, which provide a modicum of protection from soaring prices, are nonetheless concerned that prices will go up after the contracts run out.
Trucking companies would seem to be in the same position as airlines. But so far, demand for trucking services is so high that they are finding it easy to impose contractual fuel surcharges that they often had to forgo when demand was slack.
"You'd think we'd be hard hit, but the truth is, our contracts shield us from the oil spikes," said Mr. Zollars of Yellow, which has added a 7 percent fuel surcharge to its rates.
Full-load truckers expect to feel squeezed, however. Although most expect to recover at least 95 percent of their increased fuel costs from surcharges, their operating margins are much slimmer than those of railroads or haulers like Yellow, which usually combine loads from different customers in the same trailer. The price for the diesel fuel that trucks use has risen more than 26 cents a gallon nationwide over the last few months and has gone up even more in California, where truckers do a great deal of business carrying imported goods inland from ports.
"Every penny that gas spikes costs us $2 million annually, and if we have to absorb even 5 percent of the increase, it cuts our margins in half," said Thomas Nightingale, vice president for corporate marketing at Schneider National Inc., a privately held trucker in Green Bay, Wis.
For now, Schneider remains profitable, Mr. Nightingale said, but "the price hikes have caused a severe cold that could yet become pneumonia if prices keep going up."
Still, the industries that stand to be hurt badly by high oil prices seem to be outnumbered by those that expect to roll with the punch, or even profit by it.
For example, oil accounted for only about 3 percent of the fuel that utilities burned to generate electricity last year. The American Electric Power Company, the nation's largest generator of electricity, used even less than that. Its fleet of coal barges, however, uses 60 million gallons of diesel fuel a year, while its 9,000 maintenance and repair vehicles use 10 million gallons. The utility expects the increase in the price of crude oil to add more than $10 million to its gasoline bill this year. And its executives recognize that rising oil prices often have a ripple effect to the costs of other fuels. Still, they expect to easily offset the costs through tweaks like rescheduling maintenance projects.
"Ten million is a big number, but it's a pretty small part of our $3.5 billion operating and maintenance budget," a company spokesman, Pat D. Hemlepp, said.
Alternative fuels may further lower the cost of running corporate fleets. Monte Shaw, a spokesman for the Renewable Fuels Association, expects that, in large part because of environmental concerns, refineries will blend about 3.5 billion gallons of ethanol, derived from corn, into gasoline this year, further reducing the use of oil.
And "we keep seeing more cars that can run on high ethanol fuel," said Mark K. Lambert , a spokesman for the Illinois Corn Growers Association.
The search for oil substitutes can also help companies like Joy Global, which makes mining equipment, or Caterpillar Inc., which makes trucks that cart coal from mines.
"Oil prices will not represent a material change, but on the margin, rising oil prices can make people even more aware of the need for alternate types of fuel," said David Bleustein, an analyst at UBS.
In fact, in some industries higher oil costs are actually restoring competitive equilibrium. Many chemical companies have substituted liquid natural gas for oil as their main raw materials. The competitive advantage that had given them on the global market was pretty much wiped out when gas prices began to soar two years ago. According to Mr. Lipton of Nova, the ratio of oil to gas prices, which historically sat at 10 or even 15 to 1, had narrowed to less than 6 to 1, the point at which oil's higher energy value makes it more economical. Today, natural gas sells for about $6.50 per million British thermal units, putting it at a disadvantage to $30-a-barrel oil but moving it back into a 6.5-to-1 ratio with $41-a-barrel oil.
"The costs are back in equilibrium, and users of natural gas are again favorably positioned," Mr. Lipton said.
Indeed, Nova and other makers of polyethylene, which is used in plastic products like supermarket bags, have already raised prices by 5 cents a pound, to 45 cents.
Even companies that make consumer products are not panicking over the potential cutback in consumer spending if gasoline prices stay high.
"Despite paying higher prices for their gas, consumers will still be washing clothes and cleaning their homes," said Linda Ulrey, a spokeswoman for Procter & Gamble, which makes Tide, Mr. Clean and other household products.
Sales at the Lowe's Companies, the chain of home improvement stores based in Mooresville, N.C., have risen along with the economic recovery, and its executives do not expect consumer penny-pinching to halt that trend. In fact, it may even bolster it.
"People will still fix leaks and replace broken washing machines," said Chris Ahearn, a Lowe's spokeswoman. "And if high gas prices keep them at home more, they might be spurred to replace that worn carpet or buy that new backyard grill."