Oil Glut, Price Collapse Spread Across World’s Economies : Ripple Effect at U.S. Firms Unmistakable

Plastic trash bags begin life as crude oil, so you’d think trashbag prices would have fallen by now. But a funny thing happened on the way from the oil field to the garbage can.

While crude-oil prices were plummeting more than 30% in December and January, the price of ethylene--an important interim product as oil is mysteriously transformed into trash bags, false teeth and so forth--was shooting up nearly 20%.

This seeming affront to logic was the result of a refinery fire in Texas and other unconnected events which created a temporary shortage of ethylene and made it dearer, according to the magazine Chemical Marketing Reporter.

The hiccup in the price of ethylene--the most widely used petrochemical, consumed at the rate of nearly 150 pounds a year for every American--is one of the quirkier examples of why lower oil prices have been oozing, rather than gushing, through the economy.

Meanwhile, middlemen and retailers are seizing profits; 90-day contracts for raw materials continue to reflect pre-collapse prices, and refiners or their customers continue to work their way through oil whose cost predates the tumbling crude-oil prices.

Moreover, energy isn’t as important as it was at the time of the energy shocks of 1973 and 1979-80. Those events so shocked the industrialized world that it has partly “de-energized” itself, one economist says, especially reducing its reliance on oil.

Besides, in the marketplace, what goes up seldom comes all the way back down.

“It’s like candy bars and the price of sugar,” says Stephen Smith, a senior vice president at Data Resources in Lexington, Mass. “If the price of sugar goes up, everyone raises the price of candy bars. But how many people cut the price of their candy bars when sugar prices go down?”

Yet while it might not be happening as quickly as consumers would like, the ripple effect of the oil-price collapse is now becoming unmistakable. And it will accelerate between now and June.

Gasoline priced at less than $1 a gallon has become common, if not yet the rule. Some companies say they are now beginning to see lower prices for certain petroleum-based raw materials that, in such industries as chemicals and plastics, account for 30% to 60% of production costs. Factories and electric utilities have begun switching from natural gas to suddenly cheaper fuel oil to fire their boilers.

Indeed, the lower-priced oil flowed fast enough to drive January wholesale prices down 0.7%, the biggest monthly decline in the producer price index in three years. More specifically, wholesale prices for consumer goods dropped 0.8%.

The consumer price index for January, which was released last week, tended to confirm the obvious--that the full oil-price cuts aren’t being passed through to consumers. Still, the CPI, a key index of inflation, declined to a nominal 0.3%.

Six-Month Lag

The biggest effect on inflation ought to occur two to six months after the first decline in crude-oil prices, according to economist Allen Sinai of Shearson Lehman Brothers. Assuming that oil prices have stopped falling, which isn’t at all clear, that would cover February through May as “older,” higher-priced oil is used up, contracts are renegotiated and competition beats down prices.

In petrochemicals, for instance, many contracts are renegotiated quarterly. “The second quarter is when there’ll be no more reason for anyone to say, ‘My prices haven’t come down,’ ” says Vincent O’Sullivan of Chemical Marketing Reporter.

Later this the year, the anti-inflationary effects are expected to taper off--partly because the weakening dollar is beginning to boost prices that Americans must pay for imported goods.

While outright price cuts have already materialized in gasoline and other fuels, it remains to be seen how much of the oil cost savings will filter down to consumers in the thousands of products that contain petroleum, from textiles to fertilizers, soaps, paints, pharmaceuticals, explosives and synthetic rubber products.

When asked about the effect of the oil-price collapse on the prices they charge for the things they make, companies refuse to speculate--even in plastics, where petroleum-based raw materials can represent a staggering 60% of manufacturing costs.

Should Slow Inflation

Economists and investment analysts say there might be a period of actual deflation this year, when overall prices decline. But they say the oil-price decline and its effect on other energy costs generally portend lower price increases, and thus a reduced rate of inflation, than might otherwise have occurred.

Shearson Lehman, for instance, estimates that a $10-per-barrel drop in crude-oil prices would slow the rate of inflation--or the rate at which prices rise--by 2.4% this year from what it would have been without an oil-price cut.

In the case of plastic and chemical products, says analyst Christopher Willis of E. F. Hutton, “I don’t know that it will bring down prices. A lot of plastics (firms) have been marginally profitable for some time. But now, maybe they won’t have to raise prices to make more money.”

After guessing the inflation rate, the economists use simple arithmetic to trace other effects of an oil-price decline.

If the price of crude oil drops by $15 this year to $15 a barrel, and the U.S. economy uses about 16 million barrels of oil a day, multiply the 16 million barrels by the $15-a-barrel cut by 365 days. The answer is about $88 billion that consumers won’t have to spend on oil in one form or another this year.

Savings Will Multiply

Those numbers might be meaningful to the macroeconomists, but it’s hard to appreciate until one understands that consumers will now spend those savings on something else. And then the oil savings multiply.

The boost in purchasing power is complemented by the reduced interest rates fostered by the lower inflation. Thus households and companies enjoy lower costs and higher cash flow. The result is real economic growth, which in turn lowers unemployment, boosts tax revenues, trims the need for government spending and reduces the federal deficit.

Consider the tire.

At Goodyear Tire & Rubber, it takes about seven gallons of oil to produce a typical automobile tire, including the energy used to run the factory and the petrochemicals that account for two-thirds of the weight of the tire.

Every $1 decline in the price of oil, Goodyear says cheerfully, saves up to 20 cents in the cost of making that tire. That’s about $3 per tire in production costs that Goodyear stands to save from the recent drop in oil prices.

As if that weren’t enough good news, people are likely to drive more and wear out their tires faster as gasoline prices drop. With the money they don’t spend on tires, they’ll buy more new cars which, at five tires apiece, are an even better deal for Goodyear.

Indeed, one of the biggest winners in the oil-price decline should be the U.S. auto industry, which affords one of the clearest lessons in the ubiquitousness of oil.

Push for Price Cuts

General Motors most assuredly will be leaning hard on Goodyear to cut the prices GM pays for tires. GM and its suppliers will also be reviewing the prices they pay companies such as Philadelphia-based Rohm & Haas for polymers, resins and other petroleum-based products that end up as car paint, tail-lights, turn signals, dash ornaments and even fenders.

(Forgetting its cars for the moment, GM dished out $1.6 billion last year just for the energy to run its 150-odd factories, according to Gerhard Stein, head of GM’s energy section. That’s less than 2% of sales, but Stein notes that a cut of just 10% in energy costs would save GM $160 million a year--or about $23 per car.)

Meanwhile, the oil-price decline has helped to foster other good news for Detroit. Cheaper gasoline means increased sales of larger cars. And lower world energy costs have encouraged the Japanese to let the yen gain further against the dollar--dramatically cutting the big manufacturing-cost advantage that Japan’s auto firms have enjoyed.

As such, analysts say, the auto manufacturers will find it hard to justify any price increases for the foreseeable future.

As for Rohm & Haas, analyst Willis figures that a $5 drop in the price of a barrel of oil means a $1-a-share spurt in the company’s earnings. And the price of its stock has logically been launched into the stratosphere, to $100 from $67 since mid-November.

Just as it was in the worst kind of business when oil prices soared in 1973, Rohm & Haas is watching the price downturn from the catbird seat. According to assistant treasurer Ted Suess, about 30% of the company’s production costs are linked to oil prices.

Utility Rates Ease

Utility rates have already started down, a savings that by law is passed on to consumers in California and other states. Oil prices are forcing down natural gas prices and are now nearing the point of challenging coal, the cheapest conventional energy source.

It goes on and on. The paint people--whose products are to be brushed on the houses that will be built at the lower interest rates that are likely to result from the reduced inflation that’s traceable to the fall in oil prices--are delighted.

Oil-based resins, according to technical director Ray Connor of the National Paint & Coatings Assn., “are the backbone of every paint system.”

But paint is a mere drop in the 42-gallon barrel of crude, accounting for about a pint. Even the huge petrochemical industry uses only about 1.2 gallons out of every barrel of crude oil. The residual fuel oil used to run factories accounts for just 3 gallons.

Gasoline for cars dwarfs all else where the demand for oil is concerned.

Nearly 48% of crude oil used in this country last year was refined into motor and aviation fuel, and nearly all that was for cars, according to the Energy Department. Easily the second-largest category, at 24%, was the distillate fuel oil used for home heating and diesel fuel.

Amid finger-pointing by segments of the industry and grumbling by consumers, gasoline prices have begun to fall at wildly varying rates around the country--a function of local supply-and-demand, proximity to refineries and the needs or whims of individual refiners, distributors and pump owners.

Depend on Refiners

To hear Vic Rasheed tell it, gas station owners are at the mercy of refiners. As executive director of the 60,000-member Service Station Dealers of America in Washington, he represents independent owners of name-brand service stations.

“The dealers can’t pass on price cuts they haven’t seen yet,” said Rasheed, who likens the major refiners--principally the major oil companies such as Exxon, Shell, Texaco and Mobil--to the Organization of Petroleum Exporting Countries. “The price of oil no longer controls the price of gasoline. The refiners do.”

The evidence is, however, that station owners have indeed been realizing lower costs--and hanging on to the higher profits.

According to the Los Angeles-based Lundberg Survey of gasoline prices, retail profit margins spurted by nearly 50% to 16 cents a gallon in February, compared with 11 cents a gallon in December. Survey owner Dan Lundberg adds that the dealers need the money because of the rising costs of doing business, especially soaring insurance costs.

Southland Corp. of Dallas, a refiner that has become one of the nation’s largest pumpers of gasoline through its chain of 7-Eleven convenience stores, says its refinery operation is squeezed--so the company is making up for it at the pump. The company says retail profit margins on gasoline were “considerably higher” than in December.

To economist Smith at Data Resources, this is “a stickiness in the system” that can’t continue for long. In fact, Lundberg frets that competition will force dealers to give up the healthy profit margins of recent weeks and finally slash retail prices so sharply that some dealers could be forced out of business.

Predicts Sharp Drop

At $18 a barrel for crude oil, Yale economist William Nordhaus, co-author of a study on gasoline marketing, sees a drop of as much as 25 cents to 30 cents a gallon at the pump by summer or fall.

“There’s no doubt we will see a very, very substantial effect,” he said. “The market is going to do what the market has to do.”

Meanwhile, another hiccup is in the making.

To meet a federal directive to lower the level of lead in leaded gasoline, the refiners are using increasing amounts of benzine as a substitute to perform the octane-raising role normally played by lead.

To Borg-Warner Chemicals, that just promises more mischief in the system of prices by raising demand for benzine. It is another of the oil-based feedstocks that go into its plastic pellets and, eventually, such products as plastic casings for personal computers.

“Now we’re competing with the gasoline industry,” spokesman Hess says. “We use it to make computer housings, they use it to raise octane.”