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Wednesday, 21 October 2009

Oil at $80: That's good news and bad news.

By Paul R. La Monica, CNNMoney.com editor at large

Oil prices are back around $80 a barrel for the first time in nearly a year. But is that good news or bad news for the economy? Let the debate begin.

Of course, the knee-jerk reaction is to declare that rising oil prices must be a bad sign. After all, increased energy prices could be considered the equivalent of a big fat tax increase for an already cash-strapped consumer.

Even though people don't have to pony up four Andrew Jacksons to buy an actual barrel of oil, rising crude prices obviously hurt consumers at the pump.

And in just the past week the nationwide average price of a gallon of gasoline increased by 10 cents, or about 4%, to $2.58, according to motorist group AAA.

On the other hand, oil prices were hovering around a low of near $30 a barrel back in February. And at that time, the average price of gas was below $2 a gallon. But how good did you feel about the economy back then?

Fears about a massive wave of big bank failures and another depression were running rampant. So cheaper oil and gas were little consolation.

It's hard to deny that things simply feel better now than they did seven months ago. The economy may still be in rough shape but few are predicting a financial apocalypse.

Stocks have soared in the past few months because of renewed expectations of a global economic recovery, and the spike in oil prices is also a reflection of these hopes. Sure, there are some out there who are writing off the rise in oil as another example of momentum traders playing the evil speculation game.

But many commodity experts argue that the main reason oil prices are rising is because there are signs of increased demand for oil from emerging markets such as China and India as well as the U.S. and Europe.

What's more, the continued weakness of the greenback is helping to push oil higher because oil is priced in dollars -- despite the occasional rumor to the contrary.

And the dollar's weakness is, to a certain extent, a byproduct of investors flocking to riskier assets like stocks and commodities because of the aforementioned recovery hopes.

So the most important question to ask about oil probably shouldn't be whether rising prices are bad or good. Instead, it should be this: How high do oil prices need to go before higher prices are no longer a sign of recovery but something that can actually threaten the recovery?

Oil's not well for consumers

When I last wrote about rising oil prices back in early August, several economists said that crude prices in the $80 to $90 range could lead to a further pullback in consumer spending.

Now that oil is in fact flirting with $80, those concerns have returned. And they couldn't have come at a worse time. Makers of consumer goods and retailers are prepping for the all-important post-Thanksgiving shopping season, which is already expected to be lousy.

"Higher oil prices certainly don't help. It definitely could put a damper on consumers' spending ability during the holidays," said Kurt Karl, chief U.S. economist with Swiss Re.

But the bigger fear is that if oil does reach the $80 level, $100 oil might not be far behind -- and that could really jeopardize the chances of an economic rebound.

"If oil goes into the $100 zone, then the guy on the street is going to see gas prices above $3. That would be an issue for consumers," said Jim Glassman, senior economist with JPMorgan Chase.

So will oil rise above the century mark again? That is no longer as far-fetched as it seemed a few months ago. But the oil markets have proven to be so volatile, it's anybody's guess whether oil will be closer to $100 or $30 six months from now.

Oil prices are obviously affected, like every other asset in the known universe, by the laws of supply and demand. But figuring out the supply side of the equation is hardly an exact science.

The weather can wreak havoc on production. So can various geopolitical concerns in the Middle East, Nigeria, Russia, Brazil and Venezuela.

With all that in mind, Glassman said he thinks that a so-called "new normal" range for oil could be between $60 and $80 a barrel. Karl thinks oil should eventually retreat from current levels but wouldn't rule out a move above $100 in the next few months.

"The trend is the traders's friend, and the trend is up. There are a lot of little things that impact the price of oil, and lately they all seem to add up to a $5 increase in prices every time you turn around," Karl said.

Still, not everyone agrees that higher oil prices will crush consumers.

Richard Ross, global technical strategist with Auerbach Grayson, a broker dealer based in New York, quipped that you have to wonder about how weak the economy really is if consumers are still finding enough cash to splurge on expensive new iPhones and Macs.

Of course Apple, which reported a record quarterly profit Monday, is a bit of an anomaly. Few companies have the kind of must-own cool gadgets that would cause people to splurge even during a downturn. But Ross raises an interesting point.

He argues that as long as oil prices are rising in conjunction with stocks on more positive economic news, people might accept higher energy prices as a necessary evil of a recovery.

Think about it. Nobody wants to see oil above $100 again. But if oil does climb above that level sometime in the next year and the value of your house is also increasing for the first time in what seems like eons, wouldn't you shrug off the higher prices at the gas station?

"Will anyone be happy about $100 oil and $4 gas? No. But people weren't shaking their pom poms when oil was at $32 and gas below $2 because everyone was worried about banks and the stock market collapsing," Ross said. "If gas prices went up another 20 cents or even 50 cents, people might take that trade off if it's accompanied by more signs that the economy is getting better."

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