Anxiety about crude intensifies as third quarter approaches

by Meg Richards

With crude prices at record highs and the winter heating season just around the corner, Wall Street is having a hard time dismissing worries about rising energy costs.
A number of companies have cited oil prices as they've issued third-quarter profit warnings and reports, and anxiety about crude, which neared $ 50 a barrel, has weighed heavily on stocks. There's good reason to worry: Energy costs are crimping profits at manufacturers, forcing airlines to cut flights and threatening consumer spending.

Still, some analysts are sceptical about the true impact oil will have on earnings. While the cost of crude is uncomfortably high, the prices of refined products used by consumers and businesses, such as gasoline and natural gas, have not surged at the same pace. That's because their costs are generally tied to inventory levels, rather than crude prices. But for companies that might be in danger of missing expectations, oil could seem like a handy excuse.
"Let's face it, if earnings comparisons don't work out too well, they look for scapegoats," said Sam Stovall, chief investment strategist with Standard & Poor's. "If energy prices are in the news, it's easy to blame it on them."

One in five companies say lofty oil prices are hurting their earnings, according to a survey issued by Financial Executives International and Baruch College's Zicklin School of Business, and 36 % of manufacturers have reported a negative impact. But two-thirds of CFOs surveyed said earnings are not tied to the price of oil in any significant way.
Those feeling the pinch include the highest energy consumers air transporters, who must pay more for diesel fuel, makers of agricultural products like fertilizer, and chemical producers.

If you look around, you start to realize energy really is everywhere. Petrochemicals are used to make everything from plastic and synthetic fibres in clothing and carpets to vinyl siding on homes.
"Underneath the surface, what businesses and consumers really spend their money on is refined product, and those prices have been coming down," said Jeff Kleintop, chief investment strategist for PNC Financial Services Group in Philadelphia. "Fed Ex doesn't put crude in their trucks."

There are essentially two ways energy prices can affect corporate bottom lines: They can raise business operating costs and, to the extent that they impact consumer spending, dent sales. Some retailers, including Wal-Mart Stores, have in recent months blamed lower-than-expected results on slow consumer spending.
After gasoline prices peaked in mid-May, that might have been genuinely true, Kleintop said. It makes sense that lower-end retailers would see the effects first, because rising energy costs have a greater impact on their customers.

But there's some reason to believe the worst is behind them, as gas prices declined through the summer and unseasonably cool, wet weather kept utility bills modest. That doesn't mean consumers won't feel another pinch in the months ahead.
Heating oil prices are on the rise, and refiners are racing to build up supplies following production slowdowns in the wake of Hurricane Ivan, which disrupted drilling and shipments from the Gulf of Mexico. But at this point, if companies that are not big energy consumers blame less-than-stellar results on high oil prices, it would be wise to view their statements with a jaundiced eye.

"We'll see a number of companies that are second or third tier in their industry, and if they're going to miss expectations, they'll cite energy costs," Kleintop said. "You have to wonder why it would be hitting this company and not that one. In some cases, you might be looking at excuses instead of business fundamentals."
Interestingly, consumers are spending less on energy than they have in the past about 5 % of their total outlay goes toward energy, compared with 8 % in the 1980s and 6.5 % in the 1960s and '70s. This is partly because everything from factories to cars and household appliances are more energy efficient.

But there's no denying that paying more at the pump carries a psychological impact, which could hurt the consumer discretionary sector eventually.
"This is part of the reason why we have a flat stock market for the year," said Richard E. Cripps, chief market strategist for Legg Mason of Baltimore, "The economy is doing well, what's changed is profits are getting squeezed, profit growth is not accelerating, and oil is a big factor in that."

Many analysts say oil would be more fairly priced at $ 30 to $ 35 a barrel, but terrorism fears and weather-related production slowdowns have kept it at much higher levels. The greatest unresolved issue is where oil prices are going for the long term and how much the market can hope they'll recede, given the rapid growth of global demand.
"Demand right now is accounting for 97 % of production. That's the highest we've had in three decades, and there's no spare capacity," Cripps said. "Yeah, there's terrorism. But we're simply growing. China is growing, India is growing, this is the new world. Economic growth is going to be crimped, profitability is going to be crimped... and that's what Wall Street is looking at."