The Market Can't Handle Skyrocketing Energy Prices

On Saturday, along with a breakfast far too sumptuous for my diet, I devoured a Wall Street Journal article featuring a question-and-answer session with 89-year-old investor and financial historian Peter Bernstein. Bernstein, said the article, believes that our economic woes are the worst he's seen since the Great Depression and that they will continue to plague the markets for far longer than many people expect.

He thinks that, rather than the traditional V-shaped business cycle, we could be in for one that'll look more like an L. His main reasons are the housing debacle and the subsequent poisoning of the world of credit. He makes some very good points, but noticeably absent from the discussion is, I believe, the No. 1 reason the markets are in for tough sledding for a long, long time: energy prices that just might be headed for the moon.

Let's start on the oil side, although as a culprit crude is clearly being paired with natural gas in wreaking inflationary havoc on the economy. But with the likes of ExxonMobil (NYSE: XOM), BP (NYSE: BP), and Chevron (NYSE: CVX) set to report this week, oil prices and profits are sure to re-emerge in the media's crosshairs.

A crude bottle rocket
It wasn't long ago -- fewer than five years, actually -- that crude prices were well below $40 a barrel. In 1998, admittedly amid a dip, they averaged less than $12 nominally and just over $15 adjusted for inflation. On Friday, they came a within hair's breadth of hitting $120 a barrel.

Beyond that, most energy seers think that in just the next couple of decades, we'll need to raise worldwide production from the current level of about 86 million barrels a day to the equivalent of 115 million barrels. That growth will need to occur in the face of declining output in many of the world's key producing horizons, which leads me to believe that we'll be hard-pressed to raise daily production much above 90 million to 100 million barrels.

If that doesn't send chills down your spine, a Goldman Sachs analyst thinks crude could rise to $200 a barrel -- perhaps this year -- if there were any sort of supply disruption. Such an event could occur over something like the incident Friday in the Persian Gulf, when two boats -- possibly from Iran -- received warning shots from a ship under contract to the U.S. Defense Department.

Agony at the pump
But while gasoline prices have been slower to climb than crude levies, they nevertheless have reached a per-gallon average close to $3.50 across the nation, and almost $4.00 near San Francisco. Increases to those levels are felt by all Americans, particularly those living paycheck to paycheck and perhaps commuting long distances to work.

At times like this, I'm propelled back to my macroeconomics classes, where perhaps the key piece of wisdom imparted was that the gross domestic product is the sum of consumer spending, business investment, government spending, and net exports. Most importantly, consumer spending accounts for about two-thirds of the total. So if you effectively raise taxes on consumers in the form of skyrocketing energy costs, you risk hammering the economy -- perhaps permanently.

Add a little gas
And oil isn't the only issue here. As the Journal also detailed in a recent lead article, natural gas prices in the U.S. have risen more than 90% just since August. But with the world's increased ability to liquefy the fuel by chilling it to minus 260 degrees Fahrenheit -- or about the level my wife likes to keep our house -- it can be shipped around the world by tanker.

Our problem in the U.S. is that nations like Japan are willing to pay double what we pay for gas shipments. And with natural gas still costing half of what oil brings on an energy-equivalent basis, many observers think gas price appreciation is just beginning. It's important to note, however, that this isn't a universally shared opinion: Chesapeake Energy (NYSE: CHK) CEO Aubrey McClendon apparently believes that U.S. natural gas production growth can minimize future price hikes.

Conclusion
My belief, however, is that while Bernstein is correct, malaise in housing and the world of lending will eventually cease to be such a disruptive force for our economy, and the likes of Citigroup (NYSE: C), Bank of America (NYSE: BAC), and Merrill Lynch (NYSE: MER) will return to normal. However, especially in the absence of a well-defined national energy policy, oil- and gas-induced turmoil may increase to the point where it seriously hinders our own and the world's economies.

All this, it seems to me, argues ever so loudly for Fools to keep a close eye on oil and gas companies -- the producers and the service providers -- and to weight their investment portfolios accordingly.


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