July 15, 2006

Oil briefly leaped above $78 a barrel Friday before settling at a record high for the second day in a row as traders worried that escalating violence between Israel and Lebanon could spread to the oil patch.

Friday's close of $77.03 a barrel for August delivery of U.S. benchmark crude was up 33 cents from the previous day's record. The prices of longer-term futures contracts — promising to deliver crude between next December and July 2007 — soared over $80 a barrel.

The escalating violence triggered another big dive by the U.S. stock market, where anxious investors eyed the possibility of higher energy prices cutting into consumer spending and corporate earnings, thereby slowing the economy.

The Dow Jones industrial average skidded 106.94 points, or 1%, to 10,739.35, its third straight triple-digit decline and fourth in the last six sessions. Other indexes also sagged, with the tech-heavy Nasdaq composite index giving up 16.76 points, or 0.8%, to 2,037.35.

For the week, the industrials fell more than 351 points, or 3.2%.

"Geopolitics rule the day," said Stephen Schork, editor of an energy-market newsletter. "Right now, $80 is a given…. How much higher can we go? There's no telling."

Anthony Sabino, an energy attorney in New York, called the two-day oil surge a hysteria that ignored the realities of supply and demand.

"Certainly, we live in a troubled world … but there's still plenty of oil flowing, the refineries are operating and there's been no real threat to [cut off] oil supplies," said Sabino, a law professor at St. John's University. "The oil hysteria feeds hysteria in the stock market, and you get this avalanche of all these hysterical reactions."

The fear among some oil traders is that Israel's move on Hezbollah militants could ultimately draw in Iran, a country known to support Hezbollah. Iran, the Middle East's second-largest oil producer, is already at odds with the U.S. and other nations over its ambitions for a nuclear program.

Energy-market trackers estimate that as much as $20 of the current oil price can be attributed solely to fears over possible disruptions from local unrest or hurricanes in oil-producing areas.

"The only thing we can hope for," Sabino said, "is that things on the world stage will cool off a little bit, and the market will step back and say, 'OK, things aren't so bad.' "

It's a near-certainty that the recent jump in oil prices will trigger new price increases at gasoline pumps across the country, where demand for fuel remains strong even though many consumers are shelling out 70 cents a gallon more than a year ago.

Economists, already warily watching interest rates and inflation indicators, have begun to warn that ever-higher fuel prices might also play a role in a slowing of the economy.

Lower retail sales last month and a drop in consumer confidence contributed to worries that repeated Federal Reserve interest-rate hikes were taking an economic toll. Retail sales slipped 0.1%, their first drop since February.

Traders also were unnerved when bellwether General Electric met, but did not surpass, second-quarter earnings estimates. Given GE's reputation for beating estimates, its results fed concerns about corporate profits the rest of the year. GE shares closed down 56 cents at $32.11.

The economic and geopolitical worries are prompting investors to shun risk and to scurry in search of perceived safe investments, such as gold. Gold futures shot up $13.70 an ounce to $666.60 in New York trading.

The benchmark 10-year U.S. Treasury note slipped to 5.06%, from 5.07% on Thursday. Yields on bonds fall as their prices rise.

Unlike the market's sharp downturn in the spring, which was driven primarily by concerns about inflation and interest rates, the recent selling has been a reaction to the sudden eruption of tensions in the Middle East, said Jim Paulsen, chief investment strategist of Wells Capital Management.

However, if tensions subside, stocks could recover fairly quickly, he said.

"If there's escalation of the conflict it could get worse" for the market, Paulsen said. "But it also could clear up very fast, unlike if it was a major economic problem. It's hard to turn that ship around very fast."

In other market highlights:

• Retailers lost ground amid fears that higher gasoline prices could crimp consumer spending. Wal-Mart Stores slumped $1.11 to $43.05, and Target retreated 76 cents to $47.74.
• Homebuilders and mortgage lenders slipped amid signs of a continued slowdown in the housing market. KB Home fell $1.75 to $39.92, and D.R. Horton dropped $1.66 to $21.20. Countrywide Financial, the nation's largest mortgage lender, gave up $1.12 to close at $36.82.