Money and Main Street

$70 oil menaces budding recovery

As oil prices rise, some say already weak consumer spending is in danger of taking an even harder hit.

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By Steve Hargreaves, CNNMoney.com staff writer

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NEW YORK (CNNMoney.com) -- Two weeks change a lot in the oil markets.

At the end of May CNNMoney.com ran a story asking if $60 oil will kill any economic recovery. 'No," most analysts said - consumers could shoulder $60 crude, and analysts didn't see prices going much higher.

Now oil is touching $70 a barrel. Goldman Sachs recently said it sees crude at $85 by the year's end. With the economy still on life support, oil is drifting dangerously close to being the wet blanket at the recovery's party.

Talkback: Will $70 oil snuff out any economic recovery?

Many say consumer spending - which accounts for over two thirds of the nation's economic activity - takes a big hit when crude hits $100 and gas $3 a gallon. Some say it's more like $125 crude and $4 gas. Others say that during a recession $80 is the breaking point.

But putting a number on it is almost beside the point. The higher it goes, the more it hurts.

"People say it doesn't matter until gas gets to $3 or $4 a gallon," said Peter Beutel, an oil analyst at Cameron Hanover. "But every time it goes higher it takes that much more money out of consumers pockets."

Beutel can even tell you how much. For every 10 cent rise in gas price, people can spend $40 million less a day on other things.

"We're losing opportunity every time the price rises," he said.

Most analysts say prices aren't rising because of an actual shortage, but rather because Wall Street is again retuning to the crude market.

China is using a bit more oil, but worldwide demand remains slack. The government is reporting the world's spare production capacity - the difference between what the world pumps and what it could pump and a key cushion against supply disruptions - has risen to levels not seen since 2002. Oil in storage is also near record highs.

"Crude oil prices appear to have been divorced from the underlying fundamentals of weak demand, ample supply, and high inventories," Adam Sieminski, chief energy economist at Deutsche Bank, wrote in a recent note.

The rise in prices is instead being driven by a falling dollar and investor interest.

A falling dollar is causing oil to rise as investors buy crude as an inflation hedge. Money is also coming out of bonds and other safe haven investments and back into oil, stocks and riskier assets as early signs suggest the economy may be improving.

While motorists may be miffed to learn that Wall Street is the main driver for the recent runup in fuel prices, it's probably not such a bad thing that investors are expressing confidence in the economy. Renewed lending and job creation will likely outweigh any pain people may feel from paying higher gas prices.

Plus, oil prices have to be at least $40 a barrel to make it profitable for oil companies to bring a lot of new production to market. Otherwise, we could be setting ourselves up for a potential oil shortage and a subsequent "super spike" in prices when demand eventually does return.

But the price rise is coming when America is still losing jobs and budgets are still strained.

"That has to have some kind of impact on people," said Sean Brodrick, a natural resources analyst at the investor newsletter Uncommon Wisdom. "I don't know if it will kill the recovery, but it will certainly take some steam out of it."

Still, consumers who are frustrated with rising pump prices can take some solace in the fact that because the price run up has been led by financials and not supply and demand, many analysts think it may not have legs.

"The current rally may prove fragile - eventually being undermined by still-weak fundamentals," Greg Priddy, a global energy analyst at the Eurasia group, a political risk consultancy, wrote in a recent research note. "Talk of the potential for an extreme price "spike" in the near-term is premature, and unlikely to play out."

With the economy still in a recession, most analysts don't foresee prices rising too much higher until demand actually increases.

Yet driver beware: Analysts often fail to see price spikes coming.

"At some point, seasonal factors will come into play and we will see a pullback in the second quarter," one analyst said last April, when crude was trading at a then-record $115.

Three months later crude hit $147.

Has the recession actually helped you? From lower debt payments to cheaper home prices, many people have benefited from the current downturn. If you've made out financially and want to share your story, please email steve.hargreaves@turner.com. To top of page

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