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The Oil Factor Wanes

A variety of changes means the U.S. economy is likely to survive the latest round of increasing prices with less trauma.

June 27, 2004|Warren Vieth | Times Staff Writer

Washington — Every recession of the last three decades has been triggered in part by a big run-up in oil prices. But many economists and industry experts are betting that the latest surge will be different.

To understand why, take a look at Florida Power & Light Co.

At the time of the 1973 Arab oil embargo, the big Florida utility relied on fuel oil to make more than half the electricity it generated. Stung by high oil costs, the company started diversifying into natural gas and nuclear, coal and purchased power. Now, oil accounts for only 14% of its power generation.

And so it has gone throughout the U.S. economy.

Because of a variety of changes, some born of the economic pain of past price shocks, Americans are less dependent on oil. Together, these changes mean the economy is likely to survive this round of rising prices with less trauma than suffered in the past.

The changes include tougher vehicle mileage standards and switches by homeowners to newer, more efficient heating equipment. Broader economic shifts, such as the rise of the high-technology sector and the exodus of energy-intensive manufacturing to other countries, also have made the United States less oil-hungry.

And many industrial consumers of energy have become more efficient and started using a variety of energy sources, as did Florida Power & Light. This allows them to switch to whatever fuel is cheapest at any moment.

"We found ourselves in a situation where we were going before the Public Services Commission asking for a rate increase every couple of months," said Bill Swank, spokesman for the Florida electric company, recalling the oil crisis of the 1970s. "We realized it wasn't good to have all of our generation eggs in the same fuel basket."

So the U.S. economy will be singed, not burned, by the recent oil price jump, which saw the spot price of crude hit a record $42.33 a barrel in early June before retreating to the high $30s.

If that price level is sustained, analysts and industry experts say, inflation might inch up and economic growth will slow -- though many predict a drag of about 0.5 percentage point, not much in an economy expected to expand at least 4% this year.

The Inflation Factor

"It's clearly a negative," said Stephen Friedman, director of President Bush's National Economic Council, about high oil prices. "But you have to put this in the context of all the other things that are going on in the economy. While it's a negative, we have no remote sense that it's going to derail this recovery."

Others agree that an oil- induced recession is a long shot, unless prices rise much higher and stay there for a while.

One reason the effect of oil prices will be muted, analysts say, is that prices in fact are not that high when inflation is taken into account. Although recent prices have set records, oil would have to soar to about $70 a barrel to match the highs reached in 1980, after adjusting for inflation.

But equally important are the broader economic changes that have made the United States less sensitive to oil price fluctuations. It takes about half as much oil as it did 30 years ago to generate $1 of gross domestic product, and energy expenditures take a smaller bite out of household budgets.

"The nature of the economy has changed," said Bush economic advisor N. Gregory Mankiw, who joined Friedman in a recent briefing for reporters. "We're more technology-based, more service-based. That's one reason ... oil prices may have a smaller impact on the macro economy today than was true a generation ago."

Philip K. Verleger Jr., an energy economist at the Institute for International Economics in Washington, said globalization also was a factor: "A lot of energy-intensive businesses have moved offshore. Businesses are much more efficient in the way they use energy. As a result, most manufacturers operating in the United States today are less influenced by energy prices."

It isn't only oil-dependent manufacturers that have sought efficiencies or moved to lower-cost countries. Persistently high natural gas prices also have prompted some companies to move. Because natural gas cannot be transported readily from one part of the world to another, its price can vary widely in different geographic regions.

Last year, Dow Chemical Co. closed chemical plants in Louisiana and Texas that used gas as a feedstock, shifting production to newer facilities in Germany and other overseas locations.

"As the price of the feedstock and fuel goes up, it makes it less advantageous to upgrade the technology at the old plants," Dow spokesman Doug Brinklow said. "So we decided not to."

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