By Cecilia Kang and Nell Henderson
Washington Post Staff Writers
Wednesday, August 9, 2006
As oil prices climb, the U.S. economy has become the arena for a tug of war over inflation.
On one end of the rope are business people such as Geri Gribben, a professional errand-runner in Woodbridge who handles such chores as delivering documents or waiting for the cable TV installer. She raised her hourly rate from $25 to $30 recently to cover the rising cost of filling her gas tank four times a week. Her customers swallowed the increase without complaint.
On the other end are people such as Michael Schick, vice president of Electrical Dynamics Inc., a contractor in Springfield. He's paying more for gasoline and products made from oil, but business is too competitive for him to raise prices. So he's cutting costs in other ways, such as sending workers out in smaller, more fuel-efficient trucks.
Until this spring, the Schicks were overpowering the Gribbens in the national economy, keeping inflation low even as oil prices more than doubled in three years.
But the balance is shifting. Inflation is up this year as oil trades above $70 a barrel, gasoline averages around $3 a gallon, and businesses use higher oil prices as a reason -- or an excuse -- to raise consumer prices for other items. The Federal Reserve has been raising interest rates to combat such inflation, though it decided not to yesterday after a string of 17 increases.
The question for many consumers and economists is whether the oil shock of 2006 will ignite sustained inflation that risks returning the nation -- at least in a limited way -- to the kind of psychology that pumped up prices during the 1970s and 1980s. Or will this round of inflation be a temporary uptick that recedes over time as competition forces businesses to operate more efficiently?
In theory, assuming oil prices level off, companies might have to raise prices only once to catch up. "But does it stop at that point?" said Nigel Gault, an economist specializing in North America at Global Insight Inc., a financial analysis firm.
The answer, he said, will depend on several factors: companies' power to raise prices, which reflects the strength of demand for their goods or services; the alternatives to their products; and the competitiveness of specific industries.
Gribben's Errands-on-the-Run, for example, has "pricing power" because competition is limited. Her service, even at a higher price, is an attractive convenience for many affluent Northern Virginia professionals willing to pay someone to handle tedious chores.
Gasoline prices have shot up 36 percent since the beginning of the year, Energy Department data show. Gribben hasn't calculated gasoline's share of her business costs, but she knew it was growing and that she'd have to raise prices. "I'm on the road all the time," logging as many as 100 miles in a workday, she said.
Though her business faces little competition, Gribben worried some clients would drop her service if she jacked prices too far. She boosted her rate $5 an hour, or 20 percent, and the customers stayed. "People have been understanding of my situation," she said.
Similarly, with the Washington area economy growing rapidly, local asphalt companies are so busy that they have a lot of pricing power. They will rarely bid on long-term commercial paving contracts unless they are granted "escalator clauses," allowing their prices to rise with oil prices, said Charles Hess, executive vice president of Hess Construction Co. of Gaithersburg, which manages local school construction projects.
Prices for asphalt, a byproduct of oil refining, were 10.6 percent higher in June than a year before, according to Labor Department data. "In two years, who knows? We may be at $100 a barrel" for oil, Hess said.
One multinational company with pricing power is appliance maker Whirlpool Corp., which has thrived in recent years on the U.S. housing boom and strong global economic growth, which has boosted demand for new washers, refrigerators and similar products.
Even with the U.S. housing market cooling, Whirlpool executives recently announced price increases in North America of 6 percent to 12 percent to cover a $150 million jump in costs. The company wouldn't break out fuel costs for competitive reasons, but spokesman Christopher Wyse said Whirlpool had hefty transport costs and uses plastics, paint, resins, hoses and other goods derived from oil.
Delivery companies like FedEx Corp. and United Parcel Service Inc., which buy jet fuel for their planes and diesel for their trucks, have been raising fuel surcharges. UPS, for example, has long collected fuel surcharges, but over the past year has raised the one on air deliveries to 16 percent, from 2.5 percent, spokesman Norman Black said.
Even with such pricing power, UPS is doing everything it can to cut fuel costs, an imperative for a company that operates 91,700 trucks and 281 jet planes, Black said. UPS forbids its drivers from idling their truck engines at delivery stops. It bargains hard for fuel discounts. It runs 1,500 trucks on alternative fuels and sponsors research in that field.
"Some of these things were started, and some were accelerated, because we can't believe what's going on with oil prices," Black said.
Electrical Dynamics, by contrast, doesn't have much pricing power. The Springfield firm bids on contracts awarded by home and office builders. The company faces numerous competitors trying to offer the low bid, said Schick, the company vice president. So instead of hiking prices, the company has had to find other ways to absorb rising costs for gasoline, raw materials and electricity.
Oil is just one factor pushing up the company's costs. Global demand for other raw materials is soaring, too, largely because of rapid economic growth in Asia. The cost of electrical wire, for example, is $100 a roll, up from $20 two years ago, reflecting higher costs of copper, plastic insulation derived from oil and the fuels consumed to make and transport the wire.
So the company is buying more supplies in bulk at a discount and is talking to other businesses about pooling resources to buy in volume at lower prices. If costs keep rising, the company will have to consider raising prices, Schick said. "We're trying to fight it off as long as we can."
Airlines have raised fares this year, enjoying some newfound pricing power after grounding many planes, trimming routes and flying fuller aircraft. Such steps eliminated much of the excess capacity that had helped keep fares down since the 2001 terrorist attacks and economic downturn.
But airlines say fares aren't rising as fast as some of their costs. Ticket prices were up 11.3 percent in June compared with last June, according to the Air Transport Association, which represents the major carriers. Meanwhile, fuel costs, which account for about 25 percent of industry operating costs, were up 29 percent in the same period.
Airlines' pricing power, though stronger these days, is still limited by competition -- not just from other carriers but also because travelers can drive, hop a train, hold a video conference or stay home if fares rise too much, said ATA chief economist John Heimlich. These are among the reasons the U.S. airline industry will probably lose money in 2006, for the sixth consecutive year, he said
The airlines may eke out a profit next year, Heimlich said, in part because they are working to improve fuel efficiency.
As higher oil prices work their way through the economy, it remains unclear whether inflation will subside -- or take off.
The past year marked the end of a long period of low inflation. From 1992 through 2005, the Labor Department's consumer price index, a widely followed inflation gauge, rose 2.6 percent a year on average, far below the double-digit inflation that wracked the economy in the 1970s and 1980s. But the gasoline shortages and other problems that followed hurricanes Katrina and Rita last year sent prices up 4.7 percent for the year ending in September, the highest inflation in 14 years. For the year that ended this June, consumer prices rose 4.3 percent, well above the level that most economists consider desirable.
Federal Reserve policymakers have raised interest rates steadily for more than two years to cool the economy and keep prices under control, and they predicted recently that inflation will drift downward over the next 18 months. They voted yesterday to leave rates unchanged, breaking a string of 17 straight increases, but said they would continue watching inflation and other economic measures to decide whether it would be necessary to raise rates again.
Far from such high-level policy debates, business people struggle daily with higher oil prices. At the Woodbridge gas station where Geri Gribben fills her tank, prices are bumping $3 a gallon, prompting her to weigh raising her hourly rate again.
"I'm thinking of it," she said.