The Wall Street Journal Education Program

Weekly Review & Quiz

Covering front-page articles from September 24 – 30, 2005

Professor Guide with Summaries Fall 2005 Issue #6

Developed by: Scott R. Homan Ph.D., Purdue University

Questions from The First Section, Section A

Why the World Is One Storm Away From Energy Crisis

By CHIP CUMMINS in London, BHUSHAN BAHREE in New York and JEFFREY BALL in Dallas
September24,2005;PageA1

http://online.wsj.com/article/0,,SB112751943168550653,00.html

As Hurricane Rita barrels through the heart of the U.S. oil industry, the world once again finds itself just a storm away from an energy crisis.

Whether or not Rita is that storm -- it was downgraded to a Category 3 hurricane yesterday afternoon -- it and Hurricane Katrina have driven home a hard lesson: In a world straining at the limits of oil supply, even relatively small disruptions can drive prices haywire and ricochet among consumers and companies. That has long-term implications for consumer and corporate spending and U.S. energy policy. As devastating as Katrina's human toll was, the storm should have been a relatively small disruption for the global petroleum system. Though Katrina sank more than 50 oil and natural-gas production platforms in the Gulf of Mexico and knocked out about 1.5 million barrels of daily oil production, the storm was only 10th on a list of 11 top shocks of recent decades, according to the International Energy Agency. Yet Katrina had a wide impact because it hit at a time when markets for crude oil are the most stretched they've been in a generation. The global energy system that has powered the world economy for 25 years is severely strained. Demand for oil is growing faster than supply, thanks to America's love of sport-utility vehicles and China's booming economy and embrace of the passenger car.

Globally, producers today have at most 1.5 million barrels of spare crude-pumping capacity to tap in a crunch -- about the same amount currently shut down by Katrina and Rita. A cushion of at least 4% of demand, or roughly 3.5 million barrels these days, is needed to really insulate consumers from supply shocks. That in part explains the worries that surrounded Rita as it swept across the Gulf of Mexico this week. As of late yesterday, the storm was expected to make landfall early this morning in eastern Texas. Together, the summer storms have stoked growing unease that the world is vulnerable to even minor supply shocks. And there isn't a quick way to square the circle -- beyond, perhaps, a permanent increase in prices that would chill demand. "There is no magic bullet," says John Browne, the chief executive of BP PLC. "You can't just fix one thing."

Ultimately, the prospect of an energy crisis depends on a few big factors: whether the industry can develop fresh crude supplies fast enough, whether demand can be tamed and whether the global refining bottleneck can be broken.

On the supply front, the outlook for quick relief is bad. The cheap gas prices of the 1990s prompted oil producers to cut costs, limit investment on exploration and production and consolidate through mergers. They also began using high-tech management systems to reduce their stockpiles of crude oil and gasoline, mirroring the just-in-time technology that Dell Inc. and others used to cut costs. That approach has left much less cushion when a disaster knocks out fuel production. Gasoline inventories for the first six months of 2005 averaged 23.9 days of demand, down from 27.8 days in the first six months of 1995, according to the Energy Information Administration. With oil demand soaring, investment in new production has been picking up again. Today, tiny Qatar is expected to unveil a $110 billion project-finance deal which is to fund, among other things, a $50 billion slate of new oil and gas projects. Saudi Arabia has said it will spend $50 billion to boost its pumping capacity by 1.5 million barrels a day and to build other petroleum facilities, including refineries. Oil companies are investing heavily, too. Chevron CEO David O'Reilly said this week his company and other big oil majors are set to invest $250 billion in new projects in the coming three years. But because it takes up to a decade to bring a big new oil project on line, it's unclear when this investment can bring relief -- especially if demand keeps soaring. While global demand for oil grew by 2.9 million barrels a day last year, Thierry Desmarest, chief executive of French giant Total SA, estimates oil producers can realistically provide at most 1.5 million to 2 million barrels a day of extra oil each year. "More than that is not possible," Mr. Desmarest said in an interview this month. Because of production declines in existing fields, Mr. Desmarest said, the oil industry now faces a "difficult challenge" even if world demand moderates.

1. The “cushion” needed to protect consumers from sudden price increases for gasoline is approximately:

a. 10% or about 8.5 million barrels

b. 25% or about 30 million barrels

c. 4% or 3.5 million barrels Correct

d. 1% or 500,000 barrels

2. Globally investments in oil projects are ______.

a. increasing Correct

b. decreasing

c. staying the same

d. stalled

Crash Course How U.S. Shifted Gears to Find Small Cars Can Be Safe, Too

By KAREN LUNDEGAARD
September26,2005;PageA1

http://online.wsj.com/article/0,,SB112769680728951730,00.html

For decades, whenever the federal government leaned on auto makers to improve fuel efficiency, the industry had a ready response: Research showed that lighter, more fuel-efficient vehicles weren't as safe as their heavier, gas-guzzling cousins. Even shedding as little as 100 pounds could lead to a serious increase in traffic fatalities.

The result has been a virtual standstill in fuel-economy improvements for cars, trucks and sport-utility vehicles over the past 20 years. Now a wave of new studies and technologies -- strong, light materials, better airbags and smarter designs -- are beginning to break the logjam. The upshot: A big shift in government thinking that is paving the way for regulators to revamp fuel-economy rules for SUVs and pickup trucks for the first time in three decades. The shift could have big implications for the environment and for consumers, who were beginning to clamor for more fuel-efficient vehicles even before Hurricane Katrina pushed gasoline prices at the pump above $3 a gallon. But it could significantly complicate things for the already financially strapped auto industry. Over the past 15 years, when gasoline was generally cheap, the industry came to rely on heavy, fuel-thirsty models such as SUVs and pickup trucks for the bulk of its profits. Much of auto makers' fixed costs, such as retiree expenses, labor and benefits, are similar from vehicle to vehicle. So the bigger and pricier the car or truck, the more profit it generates. To protect this profit stream, the industry has long fought calls for tougher fuel-economy rules, citing safety, consumers' preference for bigger cars and lost jobs at truck factories.

Fuel-economy policies historically have kept "the manufacturer from selling the vehicle to the customer that the customer wants to buy," says General Motors Corp. spokesman Chris Preuss. We have to do "unnatural acts in the marketplace to subsidize more fuel-efficient vehicles," while volume of profitable larger vehicles is constrained, he says. "Eventually the economics catch up with you." Spurring the change in government thinking is new research, including a study that argued that the quality of a car can play as much of a role in safety as its weight. To measure quality, the study used resale values, which tend to correlate with better design and more safety features. Honda Motor Co. also broke from the industry, commissioning studies that found reducing a vehicle's weight while maintaining its size actually saves lives. "There's now a credible opposing view to what used to be the only view," says David L. Greene, a research fellow at Oak Ridge National Laboratory, a Department of Energy research lab. A paper he co-authored in March, looking at car-crash fatality rates from 1966 to 2002, found no statistically significant relationship between fuel economy and increased traffic fatalities. Mr. Greene says that previous research that did find a correlation studied only the immediate years after fuel-economy reform when weight drops were most significant. But studied over a longer period, that correlation disappears, he says. For years, the accepted wisdom in the car industry held that, all things being equal, heavier vehicles are always safer when two vehicles crash. New studies highlight how other factors -- including a car's size, body design and advanced technology -- can do much to counteract the weight issue. The newer studies also have homed in on the downside of weight: While a heavy vehicle protects its occupants in an accident, it inflicts more damage to those it hits. That means reducing the weight of the biggest vehicles could yield dividends in both fuel consumption and safety. All of this has contributed to a rethinking of the fuel-economy regulations from the National Highway Traffic Safety Administration. Last month, NHTSA crafted new "Corporate Average Fuel Economy" rules, or CAFE, for light trucks that aim to balance safety and fuel efficiency. The old rules set an average weight target for an auto maker's entire fleet of cars or trucks, encouraging car makers to sell lots of small fuel-efficient vehicles at sometimes unprofitable prices, so they could keep selling their more profitable gas guzzlers.

The new truck and SUV rules set up six different categories of vehicle by size, forcing auto makers to improve their fuel efficiency within each category. Backed up by the new research, regulators believe the rules will yield better gas mileage without compromising safety.

3. For decades the auto industry has equated weight of a vehicle with which quality?

a. height

b. safety Correct

c. wheel size

d. speed

4. A paper looking at car-crash fatality rates from 1966 to 2002, found ______between fuel economy and increased traffic fatalities. M

a. a small statistically significant relationship

b. a large statistically significant relationship

c. a medium statistically significant relationship

d. no statistically significant relationship Correct

Greenspan Warns Of Reliance on Housing Loans

By GREG IP
September27,2005;PageA1

http://online.wsj.com/article/0,,SB112773984702852046,00.html

Federal Reserve Chairman Alan Greenspan, drawing on new research he has personally supervised, said American consumers have become enormously dependent on borrowing against their homes to fuel their spending, and that a rise in mortgage rates could trigger a spending pullback. Mr. Greenspan's new data show that borrowing against home values added a stunning $600 billion to consumers' spending power last year, equivalent to 7% of personal disposable income -- compared with 3% in 2000 and 1% in 1994. The Fed chief attributed that increase to declining mortgage interest rates, an increase in the turnover of homes, the popularity of cash-out mortgage refinancing and home-equity loans. Should mortgage rates rise, he told the American Bankers Association, turnover and borrowing would decline, consumer spending would slow and saving would rise.

That reversal need not be "disruptive," Mr. Greenspan said. Indeed, he suggested that such a reversal would bring about a welcome rise in U.S. saving and a narrower trade deficit. But he also sounded new warnings about speculation in the housing market, focusing on rising sales of second homes, though also playing down the threat of overleveraged homebuyers. Mr. Greenspan's remarks were among his most extensive to date on the scope and risks of the rise in housing prices and mortgage debt in the past decade, developments to which his own policies have contributed. The remarks suggest that while in the near term higher energy prices may be the greatest threat to consumers, in the longer term Mr. Greenspan sees a cooling housing market as potentially more significant. Last year's estimate of the value of "home equity extraction," as Mr. Greenspan calls it, was double the value of President Bush's tax cuts, as estimated by Brookings Institution scholar Peter Orszag. It's unclear how much of that home-financed borrowing was spent on goods and services, but Mr. Greenspan suggested it was about half. Much of his speech, delivered by satellite to the bankers' meeting in Palm Desert, Calif., is based on a study he began in 1999 with Fed staff economist James Kennedy. The Fed posted the study on its Web site2 yesterday. It's only the second study to which Mr. Greenspan has attached his name in his 18 years as chairman. The first was "Motor Vehicle Stocks, Scrappage, and Sales," published in 1996. The title of the latest study is even more intimidating: "Estimates of Home Mortgage Originations, Repayments and Debt on One-to-Four Family Residences." Most of its 81 pages are consumed by dense tables of mortgage and housing data, charts and explanatory appendices. Mr. Greenspan has been generally sanguine on the housing market, but less so in recent months. Yesterday, he repeated his view that there is "froth" in "some local markets where home prices seem to have risen to unsustainable levels." He said it was too soon to tell whether that froth would widen to the national market, "or whether recent indications of some easing of speculative pressures signal the onset of a moderating trend." Yesterday, the National Association of Realtors said sales of existing homes rose in August by 2% to an annual rate of 7.29 million units from July, shy of June's record 7.35 million pace. Meanwhile, the median sale price soared 15.8% to $220,000 from August last year. The median is the figure at which half sold for more and half sold for less. David Lereah, the association's chief economist, said the figures showed no impact from Hurricane Katrina.