What $100 Oil Means for Your Wallet

WITH OIL PRICES hovering around $100 a barrel, consumers worry about what sort of hit is heading to their wallets.

The 34% jump we've seen in oil prices over the past three months has largely not translated into higher consumer costs — at least not yet, says Diane Swonk, chief economist with Mesirow Financial, a Chicago-based financial-services firm. But those days may soon be ending, especially if we get a cold winter that drives up demand for oil. So far, oil refineries and gasoline stations have largely absorbed the increase in crude oil costs — in part because demand for gasoline has stayed relatively weak in the U.S. But dropping temperatures and holiday travel could mean those extra costs will be passed along to the consumer.

So what's driving the price of oil? At its core, the good old supply-demand relationship: Oil production is decreasing, while global demand is growing. Last year, world production dropped to 73.5 million barrels a day compared with 73.8 million barrels in 2005. This year's eight-month average is even lower, at 73 million. How come? A primary reason is that the oil-production companies have not invested enough in exploring new oil resources, says Chris Lafakis, associate economist at Moody's Economy.com. Meanwhile, this lesser supply is met with strong demand, driven by surging consumption of oil in Southeast Asia, particularly China.

This is where the speculators come in, explains James Williams, an energy economist with WTRG Economics, an energy research and analysis firm in London, Ark. Much like real estate speculators drove up prices in parts of the country to unsustainable highs during the real estate boom, futures traders are driving up oil prices today. They're buying futures contracts at record-high prices, essentially betting that oil will remain expensive at stipulated future dates.

Finally, because oil is an internationally-traded commodity that's priced in U.S. dollars, the weak dollar also takes a toll. "As the dollar gets weaker, oil prices get higher," Lafakis says. On Wednesday, for example, a senior Chinese official's suggestion that China diversify its $1.43 trillion in foreign-exchange reserves out of the dollar and into other currencies such as the euro, pushed the dollar to new lows and respectively, helped oil prices climb higher.

So far, high oil prices haven't yet significantly impacted consumers' wallets. That's because oil refining companies like Chevron (CVX) BP (BP) and Exxon Mobil (XOM) have been absorbing the increase rather than passing it along to consumers. Consider this: While companies made a $35 profit on refining a barrel of oil in May this year, today that margin is down to $5 a barrel, Lafakis says. At the same time, the mark-up their gas stations charge for gasoline has dropped from 90 cents to 70 cents a gallon. "That's really one of the buffers we've had," he notes.

The cost of gasoline, after all, isn't determined solely by the price of crude oil. In fact, only about 64% of gasoline prices are made up of the cost of oil, according to the Energy Information Administration. The rest is refining, distribution and marketing costs, company profits and state and federal taxes.

The reprieve on higher gas prices can be attributed to the current slow travel period, which falls between the summer and the holidays. Drivers are also easing up on the gas pedal in general. So far this year, fuel consumption in the U.S. is down 0.6% compared with the same time in 2006. That's a significant change, given that for the same period last year, consumption was up 5% over 2005. "Consumers are finally responding to the high fuel prices we've had for the past couple of years, driving more fuel-efficient vehicles and even using more public transportation," Lafakis explains.

But should the current price of oil be maintained — or go higher — consumer costs will rise. Here's how rising prices could affect you:

1. Gasoline Prices

Gas prices have increased in recent weeks, and that trend is expected to continue between now and Christmas, says Jeoff Sundstrom, spokesman for AAA. The national average retail price for self-serve regular gasoline could go above the record-high $3.23 a gallon recorded on May 24 this year, he says. Today's average price is $3.06 — a 40% increase over one year ago.

2. Home Heating Costs

Just how much your home heating costs may rise this winter depends on what type of fuel you use, says Jonathan Cogan, a spokesman for the Energy Information Administration. Heating oil is refined from crude oil, so it has a direct relationship with oil prices. Nationwide, only 7% of households use heating oil, but it's commonly used in the Northeast. Assuming average oil prices at $86.93 a barrel for the fourth quarter this year (based on October's crude oil monthly average of $85.80 per barrel, and the EIA's projected average for November at $89 and December at $86), these households will face a 25.6% increase in heating costs during the fourth quarter, compared with last year, according to the EIA.

If you use natural gas — 58% of U.S. households do, the majority of them in the Midwest and West — you have less reason to worry, says Williams. The price of natural gas does have a correlation with the price of crude oil: Many factories and power plants have the ability to switch between crude oil and natural gas for their production needs, Cogan explains. So if oil prices remain high, demand for natural gas could increase as these factories switch, driving prices up. Colder-than-expected weather could also bring bad news. Natural gas is used mainly for heating, so its price is much more sensitive to the weather than the price of heating oil, Cogan explains. The EIA projects households using natural gas to see costs go up an average 10.7% nationwide this winter.

Households using propane (only 5%) will see a 20% increase, while electricity-heated households (30%) will see a modest 2.7% increase. Click here for advice on cutting your winter energy bills.

3. Air Travel

Airlines aren't happy with oil hovering at $100 a barrel. Jet fuel, which is made from crude oil, is their biggest expense (26% of their total operating costs, according to the Air Transport Association) and any price increase will directly cut into their bottom line.

But hiking airfares isn't so easy. "The airlines have to propose a fare increase and hope that their competitors go along, and then hope that the higher fares won't scare off too many passengers," says Phil Baggaley, an airline credit analyst with Standard & Poor's. It all boils down to the strength of the economy and the competition, he explains. International routes, which are offered by fewer airlines, are typically more prone to fare increases. Competition in the domestic market, meanwhile, may keep the airlines from hiking prices, especially if the U.S. economy weakens, Baggaley says.

4. Shipping Costs

Plan to save on gas by taking to the Internet? Thanks to higher gas prices, shoppers will likely see an increase in shipping costs when ordering online, Swonk says. Even the most basic of necessities — groceries — are likely to become more expensive, as merchants will pay more to get the goods delivered to their stores, she says.

The silver lining: As consumers get smarter about comparison-shopping, merchants will have to stay competitive this holiday season. "It's now a game of discounting," Swonk says. "Wal-Mart already launched its discounted season two weeks earlier than last year."

Corrected on Nov. 12, 2007.

In the original story, the assumed average crude oil price for the fourth quarter of this year was incorrectly stated as $86.93 a gallon, rather than $86.93 a barrel.