Shades of the '70s?

Shades of the '70s?

Commodity demand is soaring, prices are spiraling upward and oil supplies are tightening. Are we going to see a rerun of 1974 and 1979? Those bad old days of long gas lines, commodity shortages, spiraling prices and stagflation?

Let's look at the omens. The Journal of Commerce-Economic Cycle Research Institute Industrial Price Index is rising at the fastest rate in 30 years (See index, Page 36). The index of raw-materials prices rose at an annual rate of 42.6 percent in the week ending Feb. 20, compared with the average of the index over the previous 52 weeks. Charter rates for container ships and bulk carriers on the Baltic Exchange are also exploding. They tend to move in sync with the rate of increases in the Industrial Price Index, says Anirvan Banerji, director of research at ECRI.

The last time commodity prices and charter rates rose this rapidly was in May 1974, several months after Arab oil producers had embargoed oil sales to the U.S., quadrupling the price of oil and touching off a decade-long round of inflation. Is this d?j? vu all over again?

The spot price of U.S. benchmark crude is hovering around $35 a barrel, up almost 20 percent in the last six months, and the persistently high price of oil futures indicates that traders think the price will stay in this range. The supply of refined products is dangerously tight, and with U.S. refineries shutting down for annual maintenance in preparation for the summer driving season, supplies aren't being built up, says Bjorn Dingsor, director of Norwegian Energy Ltd. and an adviser to Morgan Stanley on energy matters.

Dingsor is raising a caution flag about oil supplies because he thinks the market is so tight that the slightest disruption could upset the supply-demand balance as soon as the second quarter of this year. The problem is twofold. First, explosive growth in China, coupled with the resurgent global economy, is driving up demand. Chinese oil consumption increased by 11.5 percent last year. Second, the big international oil companies are not replacing their oil reserves as fast as aging production fields in the North Sea and the U.S. are being depleted. Even Saudi Arabia's fabled fields are beginning to be depleted. This is happening at a time when the world needs to find 5 million to 6 million barrels a day of new production to keep up with increasing demand.

Despite soaring prices at the pump, oil companies have little incentive to build more gasoline stocks right now, Dingsor says. He explains that the market is very "backwarded," meaning companies think they can get more for their crude as the price goes higher during the summer season. But of much greater concern for the long-term supply outlook is the fact that drilling for new reserves is down 30 percent from levels in 1997, when inadequate return on investment forced oil companies to start cutting back on exploration. That scares Dingsor because the world demand for oil is about 80 million barrels a day, and total world crude oil supply is just above that. That doesn't provide much room to accommodate growth in demand or disruption in supply. This could slow China's growth and nip the resurgent global recovery in the bud. Could we be heading into another decade of tight supplies, surging inflation and stagflation, ? la the 1970s?

In a word, no, says ECRI's Banerji. Although the Industrial Price Index is still pointing upward and oil prices are high, other prices are level or falling. One reason for this is continuing productivity increases and the fact that so much of the world's manufacturing is being shifted to China, which is keeping the cost of finished goods low. Overall prices are falling and inflationary pressures are subdued even though industrial commodities and energy prices are rising.

As for raw materials, Banerji finds it difficult to imagine that the index won't top out "in the not too distant future - months rather than years." When the rate of increase in the index starts to slow, even if industrial prices continue to rise, that will signal a slowing in demand and the beginning of a cyclical downturn in prices. Demand governs the timing of the cycles of price increases and decreases to a much greater extent than supply, he believes. Most economists are too focused on supply. This is true of the charter market, too, he says. The increase in the rates for chartered vessels on the Baltic Exchange will begin to turn down in tandem with the slowing in the rate of increase in the JoC-ECRI Industrial Price Index.

Peter T. Leach is senior editor of The Journal of Commerce. He can be reached at (973) 848-7105, or via e-mail at pleach@joc.com.