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The Wall Street Journal March 8, 2005 PAGE ONE Retooling Keeps Economy Growing Despite Steep Increase in Oil Prices By THADDEUS HERRICK Staff Reporter of THE WALL STREET JOURNAL March 8, 2005; Page A1 Though the surging price of oil is nearing a recent high and analysts foresee more increases ahead, greater energy efficiency and a streamlined manufacturing sector are giving the U.S. economy surprising resiliency. The economy's solid 3.8% growth in the fourth quarter underscores how the U.S. has retooled itself since the oil shocks of the 1970s and early 1980s helped induce recessions. Petroleum-intensive industries like chemicals and steelmaking have grown more efficient -- in part by moving more jobs offshore, to places where oil and natural gas are cheaper. They also make up a shrinking part of the economy, while sectors that are less energy-intensive like software or financial services play a growing role. As a result, the amount of oil and gas needed to produce a dollar of economic growth dropped by 55% between 1973 and 2003, according to the Department of Energy's Energy Information Administration. Moreover, U.S. energy expenditures have declined to about 7% of gross domestic product from nearly 14% in 1981, the agency says. Yesterday, after weeks of steady increases, oil futures rose to $53.89, up 11 cents. That's closing in on the Nymex record-high close of $55.17, which was set on Oct. 22. (See related article on page C1.) To be sure, in inflation-adjusted terms, oil prices remain well short of where they were in the 1970s and 1980s. In today's dollars, oil topped $92 a barrel in 1980. Moreover, costly oil is still causing pain. Higher oil prices are thought to have sliced as much as three-quarters of a percentage point off the country's gross domestic product in 2004, while resulting in significantly higher fuel costs for airlines and motorists, among others. A sudden supply shock could add to that significantly. And at the pump, retail gasoline prices are within a whisker of $2 a gallon for the first time in four months and are headed toward a new high, the Energy Information Administration said yesterday. Still, the U.S. economy's ability to absorb rising oil prices has led to a fundamental shift in the way economists view petroleum's effect on U.S. economic performance. The 3.8% growth rate in the fourth quarter is among the highest in the industrialized world, while inflation was relatively tame at 3% in January from a year earlier. Investors, too, aren't overly worried about oil prices: The Dow Jones Industrial Average is nearing the 11000 barrier last seen in June 2001, closing down yesterday 3.69 at 10936.86. (See related article on page C1.) Global Insight, an economic forecasting firm based in Waltham, Mass., says the surging U.S. economy wouldn't be pushed into recession even if oil was priced at $70 a barrel for two consecutive quarters, though it cautions that oil prices over $50 for "any substantial length of time" would "dent" the growth outlook. "Last year, had I said the U.S. economy would shrug off $50 oil, the response would have been, 'What are you smoking?' " says Nariman Behravesh, chief economist at Global Insight. The U.S. ability to absorb higher oil prices comes even as prices curtail growth in other parts of the industrialized world. In part that's because the U.S. economy is being juiced by more robust consumer spending and looser monetary policy, allowing it to grow despite high energy prices. But it's also because the economies of Europe and Japan were more fragile to begin with. Economic growth in the 12 nations in Europe's euro zone showed disappointingly meager growth in the second half of last year, growing just 0.2% in the fourth quarter from the third. In Germany and Italy, the economies shrank 0.2% and 0.3% in the fourth quarter, respectively. New-car registrations in Germany dropped by 2% in February, a sign that higher oil prices are undermining some of the region's most important industries. In Japan, higher oil prices are a significant factor in the near-zero rate of growth, with the cost of petroleum likely the difference between growth and contraction in the last half of 2004, economists say. What's cushioned the blow there and across much of Asia is cheap exports; gross domestic product excluding Japan grew an estimated 7.4% in Asia in 2004 -- the same as a year earlier. Much of that growth is concentrated in China, which is filled with the kinds of energy-gobbling factories that corporate America has shifted abroad. After slowing for much of 2004, economic growth in China accelerated to 9.5% in the fourth quarter compared with a year earlier. Though China remains heavily reliant on oil and gas imports, it is able to absorb some price increases because of cheap labor costs and continued productivity gains. That allows Chinese companies to produce more goods at a low price even as their energy costs rise. A report from UBS AG late last year concluded that if oil prices moved to a 12-month average of $55 per barrel, China's growth would ease by about 0.9 percentage point -- the smallest impact on any Asian economy. Still, with energy prices now expected by most economists to stay high for some time, the world is headed into uncharted waters. Many analysts anticipate the price topping $60 a barrel this year, and some say strong demand for crude oil in China and the U.S. could lead it to hit as much as $80 a barrel in the event of a major supply disruption. Pressure on oil prices also has kept natural-gas prices high, since many industrial and commercial users can use either fuel. Oil-price shocks led to recessions in 1973, 1980 and 1990, while high petroleum prices of about $30 a barrel also played a role in the short-lived recession of 2002. Some economists say it's only a matter of time before high oil prices begin to again significantly slow the U.S. economy, which they say has been boosted by tax cuts, a flexible monetary policy and a sizable trade deficit -- the result of more than $10 billion a month in imported oil, among other things. Also unclear is what effect a supply shock might have. In today's economy, demand-driven oil spikes such as today's wreak far less havoc on the economy than supply shocks in which oil is pulled suddenly from the market, as was the case during the Arab oil embargo of the early 1970s. The changing shape of the U.S. economy is reflected in the chemical industry, which uses natural gas and oil to make feed stock and to power its plants. That industry saw 90,000 jobs disappear between 1998 and 2003, about 10% of its work force, according to the American Chemistry Council, in part due to the shuttering of U.S. plants in favor of operations where oil and gas are cheaper, such as the Middle East. By selling some operations and moving others offshore, companies have reduced the effect of higher oil prices. Dow Chemical Co., for example, is developing major petrochemical joint ventures in Oman and Kuwait after closing two plants in 2003 that it acquired from Union Carbide Co. on the Texas Gulf coast, leading to the transfer or loss of 100 jobs. Last year, high natural-gas prices spurred DuPont Co. to sell its Invista unit that manufactured nylon, polyester and Lycra, trimming its operations that rely heavily on oil and natural gas to 40% from 70%. Between 1974 and 2004 the chemical industry's per-unit use of energy declined 46%, meaning the industry uses nearly half as much energy as it did 30 years ago to produce the same amount of product, according to the American Chemistry Council. U.S. steelmakers, which rely on natural gas, have a similarly reduced presence in the U.S. today, with production declining almost 12% between 1981 and 1998, to 107 million tons from 121 million tons, and overall manufacturing capability down nearly 19%. In this industry's case, the decline has more to do with increased foreign competition than outsourcing of manufacturing. At the same time, steelmakers have become more fuel-efficient. U.S. Steel Corp. uses byproduct gases from steelmaking in place of natural gas for such things as making electricity and reheating steel slabs. Dow reduced its energy use per pound of product produced by 20% between 1994 and 2004, in large part by streamlining existing facilities such as its plant in Freeport, Texas, where the boiler system was overhauled to take greater advantage of byproduct gas for significant savings. "We're more inclined to focus our maintenance on energy efficiency," says Ken Tannenbaum, who has the title of Dow's energy conservation leader. -- ----------------- R. A. Hettinga <mailto: [EMAIL PROTECTED]> The Internet Bearer Underwriting Corporation <http://www.ibuc.com/> 44 Farquhar Street, Boston, MA 02131 USA "... however it may deserve respect for its usefulness and antiquity, [predicting the end of the world] has not been found agreeable to experience." -- Edward Gibbon, 'Decline and Fall of the Roman Empire' ------------------------ Yahoo! Groups Sponsor --------------------~--> DonorsChoose. A simple way to provide underprivileged children resources often lacking in public schools. 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