How $90 Oil Affects the Global Economy

With 10 shopping days before Christmas, it’s looking more and more likely: The holiday-season price of gasoline will top $3 a gallon for the first time.

According to AAA, the national average today for regular unleaded is $2.984 – up nearly a dime over the last month. The price of crude oil is up $7 a barrel over the same period.

“Of course,” you might say, “it’s the weaker dollar. No surprise there.” Except the dollar actually strengthened a bit over the last month. And over the last three months, it’s gone basically nowhere, while crude has jumped over 12%.

3-Month Performace of Crude Oil vs. the US Dollar

And that’s West Texas Intermediate crude, the light sweet stuff that’s (relatively) easy to pull out of the ground. Brent crude – the benchmark for much of the rest of the world – is already above $90 a barrel.

$90 oil is “a mild threat to the global economy,” says The Financial Times. Could it be even worse for Americans? It’s been said that every $1 added to the price of a barrel of oil is $100 billion subtracted from GDP. Even in a $14 trillion economy, that adds up.

Case in point: FedEx just announced its profits fell 18% in the third quarter. Its fuel costs were 26% higher than Q3 2009. No doubt that’s one reason you’ll be paying 3.9% more to ship something via FedEx starting next month. (No luck switching to UPS; it’s jacking up rates 4.9%.)

So why are oil prices outpacing the dollar? As is often the case these days, we look to China for an answer.

“Last summer,” says Byron King, editor of Outstanding Investments, “the Chinese government announced that it wants domestic industries to become more efficient in their use of electricity (most of which comes from polluting coal-fired plants in China). The Chinese government enforced this edict by – literally – pulling the switches on the power grid and blacking out entire factory complexes and industrial areas. Nothing subtle about it, eh?

“So what did the Chinese factory owners do? They threw other switches and fired up their backdoor diesel generators. The result? There was an instant, sustained surge in demand for diesel fuel across China. Indeed, starting in August, oil imports surged into China, as did imports of refined diesel fuel.

“This action helped strengthen oil and refined product prices all fall across the world. Add into this the generally inflationary conduct of US monetary policy. And add on a generally declining US oil inventory as refiners crank out heating oil in anticipation of the cold winter. There’s your $90 oil.”

Dave Gonigam
for The Daily Reckoning