Think oil prices hurt now? Just wait

DALLAS, Texas Fri May 23, 2008 11:35am EDT

A driver playfully reacts looking at the receipt after filling his car at a gas station in Washington May 16, 2008. REUTERS/Yuri Gripas

A driver playfully reacts looking at the receipt after filling his car at a gas station in Washington May 16, 2008.

Credit: Reuters/Yuri Gripas

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DALLAS, Texas (Reuters) - Sky-high oil prices are causing pain at the pump, but bills for air conditioning this summer and heating next winter -- combined with rising food costs -- promise to squeeze U.S. consumers even more.

With gas at $4.00 a gallon, households already have less to spend on a new grill at Home Depot (HD.N); a vacation at Walt Disney's (DIS.N) Disney World; a new TV from Best Buy Co (BBY.N); or a new "hog" from Harley-Davidson Co (HOG.N).

And there are no signs things will get better soon for the consumer, long the driving force of U.S. economic growth.

"For the areas of the economy that rely on heating oil, high fuel prices are going to be another blow to the consumer this winter," said Jack Kyser, chief economist at the LA County Economic Development Corp.

"The hotter states will feel the pinch during the summer months but in the mid-America states where you get hot summers and cold winters, it's going to be very uncomfortable," he said.

"This is going to eat into the disposable income of American consumers -- supposing they have any left."

Oil prices, now $130 a barrel, have risen six-fold since 2002. On Wednesday, heating oil reached a record high above $3.90 a gallon and the price is expected to stay high.

Heating oil, which cost $3.29 a gallon in January, will likely cost $3.83 in December, according to the government's Energy Information Administration.

Those costs come at a time of rising food prices, forcing people to spend more on basics as wages fail to keep up. The effects on the economy could be profound.

"The American consumer will continue to pay for fuel, food and heat," said University of Maryland economist Peter Morici.

"But they will give everything else up," he said. "That's going to make it harder to sell the average consumer a television, a suit, or even a meal at a restaurant."

HARD TIMES

This could become an especially depressing reality in July and August, when back-to-school shopping starts, and in November, when holiday shopping gets under way.

Without strong sales during both of those shopping seasons, retailers including Wal-Mart (WMT.N), Target (TGT.N), J.C. Penney (JCP.N) and Sears (SHLD.O) could post bleak results for the last two quarters of 2008 and the first quarter of 2009.

For many years, the consumer has been the engine of U.S. growth, accounting for around 70 percent of the economy.

But much recent spending has been done on credit, leaving Americans with a negative savings rate.

Now that consumers have been hit by the double-whammy of a weak economy and higher costs, the question is how much damage the engine has sustained and how long it will take to fix it.

Peter Schiff, president of money manager Euro Pacific Capital, warns that after years of profligate spending, the "chickens are finally coming home to roost".

"Our whole phony standard of living is imploding," he said. "We have borrowed and spent ourselves into oblivion."

"It's amazing that people can't figure out that America is broke."

WINTER OF DISCONTENT

Diane Swonk, chief economist of Mesirow Financial, says one of her biggest concerns for the short term is that the Bush administration's tax rebates, which were designed to stimulate the economy, will be used by consumers to fill their tanks and use air conditioning as usual rather than cutting back.

Many retailers, like Wal-Mart and Sears and supermarkets Kroger (KR.N) and Supervalu (SVU.N), have offered customers incentives to spend their rebate checks with them.

President George W. Bush signed into law a $152 billion fiscal stimulus package earlier this year to provide tax rebates to 130 million Americans. Some $107 billion of the total was allocated for households.

"The tax rebate is going to be a double-edged sword for consumers," Swonk said. "When the heating bills start coming in the fall things will not look so good."

"That should contribute to a contraction in consumer spending in the fourth quarter," she added.

Swonk said that among the industries that will continue to feel the pinch is the auto industry, a major employer.

That likely means that Thursday's announcement by Ford Motor Co (F.N) that it was abandoning its long-touted goal of returning to profitability by 2009 will be followed by more bad news from Detroit.

With Ford and General Motors (GM.N) shares getting a battering on Thursday, investors were asking if the long-term prognosis of the Detroit automakers was becoming even bleaker.

"The economic circumstances are not good for Ford and they are not good for any of the automakers really; this isn't anything that is a Ford exclusive," said Erich Merkle, director of forecasting for consulting firm IRN Inc.

Edward Leamer, head of the UCLA Anderson Forecast Center, said that thanks to the combination of high spending in recent years and rocketing fuel costs, the consumer-engine of U.S. economic growth is close to failing.

"The global markets are telling us we are not as wealthy as we think we are and that we have spent beyond our means," he said. But Leamer said while the engine may be broken, the U.S. economic model is not: it just needs a new engine.

Thanks to the "rosy spot" of exports helped by a weak dollar, plus strength in commodities like coal and grains, the UCLA Anderson Forecast Center predicts the U.S. economy will suffer only a mild recession this year.

But without that retail engine of growth, "our long-term prospect is for sluggish U.S. economic growth," Leamer said.

"Unfortunately, there is nothing on the horizon in the U.S. economy that will take over from the consumer."

(Additional reporting by David Bailey in Detroit and Tom Doggett in Washington, D.C.; Editing by Patrick Fitzgibbons and Ted Kerr)

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