Who Wins and Loses When Gas Prices Skyrocket?

By Bill Saporito

It's not every day that Karl Rove gets a lesson in politics. But the President's ace strategist was brought up sharply at a recent White House meeting with a group of Republican congressional-staff chiefs when he suggested that the best approach to soaring gasoline prices was this: wait. There's no immediate fix available, so let the market work its magic, Rove said. The stratospheric pricing will reduce demand soon enough, and $3-per-gal. gas will be a memory by summer. It's basic economics.

And, if you're a Republican politician facing a re-election challenge in November, it's basic insanity. Rove should be the last person in America to have to be told that textbook economics isn't taking the campaign trip this summer with political reality. Not in a country where the right to drive 70 m.p.h. in a 55-m.p.h. zone while getting 15 m.p.g. is part of the national vehicular patrimony. The voters are getting incensed every time they drop $75 to fill their SUVs and pickups while oil companies tote up record earnings. "What upsets me more than anything is the Democrats and Republicans keep pointing fingers," says insurance salesman Bob Morris, 59, of Palestine, Texas, whose weekly gas bill for his Camry has risen to $75. "Now I'm at the point, whoever's in office, I'm ready to vote 'em out."

That's what horrifies the staff chiefs. Until now, Republicans consoled themselves in this worsening political environment with the belief that congressional elections are local popularity contests. Now that the monthly price of driving to work rivals the mortgage payment, gasoline, more than any other issue, could turn this election into a national referendum. With the G.O.P.'s popularity gauge already down a couple of quarts, Rove was told that if the White House didn't do something, anything, about energy costs, Congress could put the President in the position of using his first veto to kill a windfall-profits tax on oil-company earnings. Says a G.O.P. strategist: "People just want the oil companies whacked."

So the Republicans turned on Big Oil, an industry they normally treat like a good neighbor--or an ATM. In a particularly delicious bit of populist sophistry, the party led by two oil guys that is pro-business, antitax and antigovernment meddling was talking loudly about greedy petro-executives, IRS audits of oil-company tax returns and withdrawing $2 billion in industry-specific tax breaks over 10 years. That's about a month's worth of profits for ExxonMobil, which announced quarterly earnings of $8.4 billion. "Listen, we've got people like this that are working for a living, who are paying higher prices for their gasoline--it's like a tax," said President George Bush, standing next to local resident Michael Wade at Fayard's service station in Biloxi, Miss., where a gallon of regular sold for $2.96. "The first thing is to make sure that nobody is getting cheated."

The President visited the service station to discuss a number of largely ineffectual remedies for pulling down prices, some of which Rove had previously discussed in the staff chiefs' meeting. Bush suspended additional deliveries to the Strategic Petroleum Reserve to divert that crude to the market. He called for more tax incentives for hybrid cars, fewer environmental hurdles for refinery builders, drilling wells in the Arctic and congressional authority to raise mileage requirements on cars. Senate majority leader Bill Frist, who earlier in the week had advised voters to drive slower and get a tune-up, was fronting a Republican proposal to send a $100 rebate to most taxpayers--which they could return to the oil companies next time they filled up.

Handed the issue that could win back the House, congressional Democrats steered en masse to service stations, like NASCAR drivers pitting for gas. Following a carefully strategized plan of photo ops organized by the Democratic Congressional Campaign Committee, they staged press conferences in filling stations around the U.S. to denounce the Republicans and promote their equally ineffectual solutions. Said John Cranley, who posed near a price sign at a service station in Cincinnati, Ohio: "These gas prices represent the failure of my opponent, Steve Chabot, and George Bush to fight for the middle class. The Republicans and Steve Chabot are giving [Big Oil] $14 billion in your money." The Democratic handout proposal was even more generous. The Dems want to rescind the gasoline tax for a while--which would stimulate demand.

The fallout from gasoline prices was doubly painful for the G.O.P. because it obliterated the good news that the economy is absolutely cranking. Federal Reserve chief Ben Bernanke estimated that the economy grew nearly 5% in the first quarter, while unemployment has fallen to 4.7%, the lowest since 2001. But the price of gas isn't a mere macroeconomic figure. It's a pocketbook item that consumers feel every week. The economy required about 27% less energy to produce a dollar of GDP last year than it did in 1986, according to the Department of Energy. But gas prices are hurting consumers because real wage growth has declined over the past four years. The American Automobile Association estimated that the average driver's fuel costs will increase to 9.2-c- a mile, from 8.2-c-. Not academic, since the average commuter covers more than 8,000 miles a year just getting to work and back.

If high energy prices are hurting workers, they are devastating a number of industries, most notably the airlines. Already buffeted by bankruptcies and labor disputes, the major carriers had made steady progress in shedding excess capacity and lowering labor costs. As a result, jets are fuller. But the till is still empty. Every dollar increase in the price of a barrel of oil translates into a $365 million immediate increase in fuel costs for the 11 major airlines. Even hyperefficient JetBlue has gone into the red. "High oil prices and continued losses will probably be a slow grind to liquidation for some airlines," says Vaughn Cordle, the founder of the analytical firm AirlineForecasts. While some airlines thought they might break even this year, now the biggest carriers may lose as much as $3.5 billion in 2006, Cordle predicts. If the current jet-fuel prices hold, something else will have to give. Result? Look for more mergers and higher fares.

The spike in gas prices is the last thing Detroit needs now, especially General Motors, which had been banking on the launch of redesigned, full-size SUVs like the Chevy Tahoe, GMC Yukon and Cadillac Escalade to help boost sales this year. A few years ago, automakers could count on a core group of 1.5 million households to buy full-size SUVs, according to Art Spinella, president of CNW Marketing Research. Even before this year, higher gas prices had eroded that market. Only about 700,000 U.S. households are now in the market for full-size models. That's why automakers are switching to crossover vehicles like GM's Pontiac Torrent and Ford's Ecosport.

Oil-dependent industries that had been absorbing higher costs are also beginning to suffer. Consider the chemical industry, which needs petroleum as a feedstock, or raw material, for such products as polyvinyl chloride (for plastic pipe) and polyethylene terephthalate (for soda bottles). "You see the biggest impact across the board in plastics," says Morningstar analyst Sumit Desai. Back in 2003, hydrocarbon feedstocks and energy accounted for 36% of Dow Chemical's total costs. Last year they ate up 47% of total costs, yet the company still managed an earnings increase. But Dow reported this week that first-quarter net income fell 10% from a year ago, to $1.21 billion, despite a 3% growth in revenue, which hit $12 billion. Dow's net income dropped mostly because the cost of energy and oil-derived raw materials increased more than $800 million in the quarter. One way chemical companies are dealing with rising energy costs is to move production overseas, particularly to the Middle East, where they pay less for energy. Dow is one of the companies doing that, putting U.S. plants in jeopardy.

Economists are worried that companies are reaching the limit of being able to transfer energy-price increases to their customers in the form of surcharges. FedEx just raised its fuel surcharge on air deliveries from 12% to 13.5%. Even local pizza parlors, which have been adding a dollar or two to the bill, will reach the push-back point if the upward trend continues. "The pain at the pump this summer is going to be on truckers, taxi drivers, limo drivers, airlines, shipping companies. The question is, Do they pass it on?" says Joe Stanislaw, an independent energy adviser for clients of Deloitte & Touche.

Not everyone is unhappy with high oil prices. Besides oil companies, these are boom times for oil-field-service firms like Schlumberger, whose oil-field revenue is up 34% over last year's first quarter, and high-tech equipment makers like Baker Hughes (up 89%). Rig activity is so strong and demand for energy services so unprecedented, according to Dave Lesar, CEO of Halliburton Co., the Vice President's former outfit, that the oil-field-service conglomerate started raising prices this month. So have others. Oil-drilling ships are renting for $500,000 a day, double the charge of 18 months ago. "The price of oil is a transfer of wealth from the consumers to the producers," says Brian Gambill, senior analyst of Manning & Napier Advisors, an investment firm. "And the producers transfer their wealth to the oil-service companies because they don't have many of the technological capabilities that the service companies have."

That's good news too for oil workers, petroleum engineers and geologists, as even fields once thought tapped out are getting attention. Sites like oilfieldworkers. com are touting jobs for $100 a day, with no experience needed. Is gushing oil too icky for you? Hate living in camps outdoors? Oil companies are looking for cooks and medics too, say the ads. At oilfield jobs ok.com the come-on is for 700 jobs in Oklahoma, paying $20,000 to $60,000, with benefits, flex hours and job training. "Great opportunities for hardworking guys like you!" says the ad.

Oil has also been a great opportunity for hardworking guys who run countries that are on less than chummy terms with the U.S. Hugo Chavez and Mahmoud Ahmadinejad, the Presidents of Venezuela and Iran, respectively, have benefited from the rhetoric of U.S. foreign policy. The Administration's confrontational response to Iran's nuclear policy and Venezuela's anticapitalism is actually making those countries richer and their rulers more popular by driving up the price of oil, a commodity they possess much of. In Venezuela the self-proclaimed Bolivarian revolutionary Chavez has taken state control of some oil fields and threatened ExxonMobil and other oil companies with raising royalty payments and lowering their partnership interests.

When oil traders in New York City's Mercantile Exchange hear Iran threaten to stop pumping in a market that is already tight, they immediately bid up the price of contracts for future oil delivery. That cycle of fear isn't the only thing sending prices higher. Hedge funds, sniffing profits, are pouring money into oil and other commodities. The chase has added $10 to $15 to the price of a barrel of oil, say economists. Nor do the fundamentals of global oil offer much hope for lower prices over the long run. The growth in demand is exceeding the growth of supply by 400,000 bbl. a day, fed by the rapidly expanding Chinese and Indian economies.

Americans, however, are the original gas hogs. The U.S. uses more oil per day than any other country--4.5% of the world's population guzzling 25% of the planet's petroleum output. But voters viscerally blame their petrodependency on the man and the party in charge. In a recent CNN/ Gallup poll, 75% of those surveyed said a President could control oil prices; 71% said this President wasn't doing enough to bring them down.

Conversely, many analysts argue that the best way to create new energy sources and encourage conservation is to raise gasoline prices, not lower them. Fadel Gheit, senior energy analyst with Oppenheimer & Co., defends Exxon Mobil while blasting politicians and consumers. "We're a bunch of crybabies. They pay the equivalent of $6 a gallon for gas in Germany," he says. But with elections looming and consumers fuming, the Republicans can't ignore what every TV news show is headlining the Pain at the Pump. The cost of gas may be high now, but for the Republicans by November, it could be a lot higher.

With reporting by Reported by Mike Allen, SALLY B. DONNELLY, Karen Tumulty/ Washington, Cathy Booth Thomas/ Dallas, Jens Erik Gould/ Caracas, Marc Hequet/ St. Paul Minn., Daren Fonda, Unmesh Kher, Dody Tsiantar/ New York