Oil Prices May Send Real Estate Skidding

November 1, 2000

The dizzying ascent in world oil prices threatens to turn the good times into bad for the U.S. economy--and our housing markets could get caught in the middle as policy bodies attempt to keep the oil situation in check.

For much of this past decade, relatively cheap oil has helped fuel what’s become the longest economic expansion in U.S. history. Today higher oil prices jeopardize that record-setting expansion by dampening growth and rekindling inflation.

As of early October, crude oil prices had more than doubled over the past year and were hovering between $32 and $35 per barrel.

Although it will take some time before the full impact of those higher prices is felt throughout the economy, the unanticipated jolt has rekindled long dormant fears around the world about the harm that high oil prices can inflict across the globe. Europe is particularly vulnerable because of continued deterioration of that continent’s currency, the euro. But perhaps the greatest impact would be felt in Asia, whose economies, including Korea’s and Taiwan’s, continue to rely on oil-dependent manufacturing industries.

The U.S. is in a less vulnerable position because of the breadth and depth of its economy, but it could still feel the pain. Midway through the third quarter of the year, higher oil prices hadn’t pushed up the prices of non-energy-related products. But eventually higher oil prices will become, in effect, a tax on consumer spending. That’s not good news for this country’s real estate markets.

Although the U.S. economy is more stable and stronger than it was in the 1970s, when it was devastated by oil price shocks in 1973 and again in 1978–79, it could slip into recession in the same way it did coming off the Gulf War oil price shocks in 1990.

Two key long-term trends are threatening to keep the risks of an oil price hike here relatively high. The first is the systemic rise in oil consumption as a result of global economic growth. In some analysts’ view, global oil production is being pushed to capacity by the world’s strong economies (the U.S., Europe, and Asia) and is likely to become worse in the coming months. The second stems from a rise in natural gas prices, which rose from less than $3 per million British thermal units a year ago to more than $5 per million Btu today. That increase is having a compounding effect on the price rise in crude oil.

There are also factors working in our favor, not the least of which is the shift under way in the major economies from a manufacturing base to a technology base. That makes the world’s tech-dominated new economies less dependent on oil consumption than in the past.

There are also some policy actions taking place, including President Clinton’s initiative to sell 30 million barrels of crude oil from our Strategic Petroleum Reserve. But any impact of that policy will be more psychological than real, since the amount involved (the equivalent of less than half a day of global consumption) is too small to have much effect on prices.

At present, the housing markets haven’t felt the effects of the deteriorating energy situation. But that could change. If the oil situation worsens, the Federal Reserve may be forced to raise interest rates further next year, inhibiting the demand for homes by buyers. More restrictive monetary policy could also unnerve consumer confidence, prompting a retreat in the equity markets. Consequently, the housing markets would inherit higher mortgage rates, less job creation, and a fragile stock market--which doesn’t bode well for future homebuying activities.

On the other hand, the energy situation could stabilize, in which case the scenario painted above will never see the light of day. Stay tuned.

David Lereah is a former senior vice president and chief economist for the NATIONAL ASSOCIATION OF REALTORS®. Today, he is president of Reecon Advisors Inc.

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