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The Wall Street Journal: Crude Has Fallen 33% From July’s Record High

WSJ Chart

Rapid Plunge In Price of Oil
May Fuel Growth
Though Still Expensive

January 11, 2007 11:26 p.m.; Page A1

Oil prices fell sharply yesterday and are now hovering at their lowest levels since mid-2005, raising the prospect of significant changes in the outlook for corporate profits, consumer spending and the global economy.

Crude oil fell another $2.14, or 4%, to $51.88 a barrel yesterday on the New York Mercantile Exchange. The price has plunged 15% since the year began, and hasn’t closed as low since May 27, 2005. Oil is now down 33% from its record finish of $77.03 on July 14.
The slide, which market participants said was fueled in part by speculative hedge-fund trading and a retreat by other investors, helped send stocks higher as investors bet lower energy prices would fatten corporate profits and strengthen economic growth, particularly in the U.S., the world’s leading oil consumer. The Dow Jones Industrial Average jumped 72.82 points, or 0.59%, to a record close of 12514.98. (See related article).

The price of oil tends to be volatile, and it could bounce back quickly. But if sustained, the decline in prices would have a big impact on everything from the American consumer to the profits of giant energy companies. It also could dent the revenues — and the political clout — of major oil-producing nations like Russia, Iran and Venezuela.

A senior official of the Organization of Petroleum Exporting Countries said yesterday that OPEC will consider the need for an emergency meeting to weigh what it should do to halt the price slide. OPEC already was cutting back its production sharply, the official said. He didn’t specify whether the cartel would consider cuts beyond the 1.7 million barrels a day it has already pledged to remove from the market.

If lower oil prices lead to a reduction in what American consumers spend on gasoline, it would leave them with more money for all kinds of discretionary purchases, such as restaurant meals, movies and vacations. That spending could provide a welcome cushion for the U.S. economy, which is grappling with a sharp downturn in the housing sector. It could also give a boost to airlines and auto makers, which have been hurt by high fuel prices.

As yet, the drop in oil prices hasn’t produced much relief at the gas pump. Regular gasoline is selling at a nationwide average of $2.28 a gallon — down from more than $3 this summer in many parts of the country — but just a penny less than in December, according to auto club AAA.

Nonetheless, oil’s pullback “is coming at a great moment for the U.S. economy,” says Ethan Harris, chief U.S. economist at Lehman Brothers in New York, who estimates that each $10 reduction in oil prices adds about a half percentage point to annualized growth in inflation-adjusted gross domestic product — a broad measure of economic activity.

“You’re worried about this one-two punch from housing — first construction collapses, and then the consumer collapses. Lower energy prices are acting as a sort of smelling salt,” Mr. Harris said.

Indeed, many economists credit the retreat of energy prices from their summer peaks for a recent bout of stronger-than-expected economic performance. Nonfarm payrolls in the U.S. grew by a seasonally adjusted 167,000 jobs in December, and economists expect inflation-adjusted consumer spending to have grown more than 4% in the fourth quarter of 2006. That has led some to raise their estimates of inflation-adjusted GDP growth in the fourth quarter to an annual rate of more than 3%, compared with forecasts of about 2% just a month ago.

The added impetus for the U.S. economy could change the picture for the Federal Reserve, which is trying to keep short-term interest rates high enough to keep inflation under control, but not so high as to cripple the economy. In recent months, prices in bond and futures markets have suggested that investors expect a slowing economy and receding inflation pressures to allow the Fed to lower interest rates in 2007. As oil prices have fallen, though, those expectations have changed.

“If this acts like a tax cut and consumers spend a lot of it, then it just makes the Fed more and more likely to stay on hold and to watch carefully what happens to inflation,” said Richard Berner, chief U.S. economist at Morgan Stanley in New York. In futures markets yesterday, investors placed a 30% probability on the Fed lowering short-term interest rates to 5% by July from the current 5.25%. That was down from 44% Wednesday.

The strength of the U.S. and global economies is one reason many doubt oil prices will remain weak for long. “I would expect to see the market bounce back,” said Nariman Behravesh, chief economist at consulting firm Global Insight. “The fundamental in terms of the oil market is demand growth, which comes from economic growth. From that perspective, we don’t see any further weakening.”

Analysts attribute lower oil prices in part to the fact that, with the start of the new year, many large institutional investors, such as pension funds, have been pulling back from energy investments. Also, unseasonably warm weather in many parts of the U.S. spilled into January, temporarily reducing oil demand.

If it continues, however, the current drop in oil prices would create a number of winners and losers. Companies whose fortunes depend on heavy oil consumption, from auto makers to airlines, could see their profits grow. On the other hand, oil companies would see their earnings fall, and investors that bet big on rising oil prices could find themselves in trouble.

Lower oil prices are “a plus for us,” said Paul Ballew, top sales analyst at General Motors Corp., noting that higher oil prices significantly crimped auto demand last year. GM is a top producer of gas-guzzling sport-utility vehicles and pickup trucks and is counting on big sales of its new Chevrolet Silverado; the auto maker has blitzed the airwaves with ads for the pickup during football games.

Auto makers suffered as sales of profitable trucks and SUVs plummeted during the second half of 2006. Gasoline prices that hovered around $3 a gallon pushed consumers away from those vehicles, especially SUVs. Light-truck sales dropped nearly 6% in 2006, according to Autodata Corp.
Even lower prices at the pump, however, wouldn’t be a panacea for GM, Ford Motor Co. or DaimlerChrysler AG’s Chrysler Group. GM and Ford, which have reported billion-dollar losses, are in the midst of restructuring plans that include worker buyouts. And Chrysler, which reported a $1.5 billion loss in last year’s third quarter, is set to announce a restructuring plan next month.

Rising oil prices over the past several years have transformed the cost structure of the U.S. airline industry, causing jet fuel to displace labor costs as the industry’s No. 1 expense. For every penny decrease in the price of a gallon of jet fuel, the U.S. airline industry saves as much as $195 million in costs annually. At AMR Corp.’s American Airlines, the world’s largest carrier by passenger traffic, that amounts to a saving of $30 million a year, or $80 million each time crude oil prices drop by $1 per barrel.

“A drop of any amount is clearly good for the industry, but it’s still really high,” said John Heimlich, chief economist of the Air Transport Association, a trade group for U.S. airlines.

Cheaper oil would sharply lower earnings of major oil-producing nations, including those in OPEC. Leo Drollas, deputy director of London’s International Centre for Global Energy Studies, estimates that OPEC’s 11 members earned $518 billion in 2006, up from $437 billion in 2005.

Assuming a fall of about $4 a barrel in oil prices on average this year, and lower output to shore up prices, Mr. Drollas estimates that OPEC export revenues would fall to $488 billion this year. But if prices average about what they are now for all of 2007, the export earnings of OPEC countries — leaving out Angola, which just joined Jan. 1 — would fall to 2005 levels, or less if the exporters group slashed output further to support prices.

Major oil companies are also likely to see shrinking earnings from their oil-production operations, the largest source of income for integrated oil companies like Exxon Mobil Corp. BP PLC, Royal Dutch Shell, Chevron Corp. and others. Yesterday, the New York Stock Exchange index of energy shares was down 11% from a recent peak on Dec. 14. Over that period, Exxon Mobil shares have fallen 9.8%, BP shares have shed 9.5%, and Chevron is down 9.6%.

–Mike Spector and Melanie Trottman contributed to this article.

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