By Liam Halligan, February 26
Ever since the early 1970s, every single time oil prices have spiked sharply (rising by 80pc or more), regular as clockwork the US has entered recession.
During recent oil price spikes, Saudi Arabia, pictured, has been able to come to the rescue and turn the oil spigot
Economics is not a science. There are no laws or cast iron relationships – as there are in “pure sciences”, such as physics or chemistry. Throughout recent history, though, there have been a handful of economic variables between which the links have been pretty solid.
Ever since the early 1970s, every single time oil prices have spiked sharply (rising by 80% or more), regular as clockwork the US has entered recession. Given America’s massive influence on worldwide economic sentiment, the past five global recessions have all come in the wake of sharp jumps in the price of crude.
Only 8 months ago, oil was trading close to $65 a barrel. Last Thursday, Brent crude momentarily skimmed $120, up 17% in a week, before stabilising at $112. If oil climbs above $120 again, and stays there, it would be 80% above where it was in June 2010. We’d then have a bona fide oil-price spike, the sixth since the early 1970s, which suggests a US recession would follow.
No wonder US stocks are now under pressure. The S&P500, having enjoyed three straight weeks of gains, fell 2% on Tuesday alone, contributing to the sharpest weekly drop in three months. This happened despite surveys showing American consumer confidence at its highest since early 2008 and the Federal Reserve’s recent 2011 growth forecast upgrade suggesting the US could expand by a very respectable 3.9%.
In Asia, stocks also suffered in recent days on fears that expensive oil will derail the global economic recovery. In Japan, stocks shed more than 3% last week. Toyota, the world’s biggest car maker, lost almost 4% of its value.
Events in North Africa and the Middle East, of course, are now looming large in the minds of investors and the broader public. In January and early February, the ousting of Tunisia’s President, followed by the dramatic resignation of Egypt’s Hosni Mubarak, sent oil prices into triple-digit territory for the first time since 2008. Since then, the shocking scenes of conflict in Libya have driven up prices even more.
Muammar Gaddafi has vowed to fight “until his last drop of blood” a growing rebellion in a country which controls Africa’s largest oil reserves and accounts for almost 2% of global production. Having been weakened by his opponents taking control of Libya’s oil-rich East and the loss of his closest advisers, Gaddafi has now reinforced his defences around Tripoli with mercenaries and tanks.
Even before Tunisia’s “Jasmine revolution”, let alone the much bigger riots in Egypt and then Libya, oil prices were rising steadily. What’s changed in recent weeks is that while the market was previously driven by the realities of rising oil demand, it is now spiralling on fears about lower supplies.
China and India between them are home to a third of the world’s population. Even in 2009, when the world economy was on its knees, these emerging Asian giants grew by 8.7% and 6.6% respectively. Last year, although the Western countries to which they sell so many goods remained relatively sluggish, China and India still both expanded by close to 10%.
As they grow, these countries are investing massively in infrastructure development – which is highly energy intensive. At the same time, more and more of their citizens are becoming wealthier, acquiring cars, air conditioners and refrigerators for the first time, while switching to protein-rich diets.
All this is obvious to oil traders – who now almost universally factor rising demand into their calculations of current and future prices. Even the International Energy Agency, a thinktank funded by oil-importing governments, which has long played down the impact of higher global oil demand, has been forced to acknowledge reality. The IEA just raised its 2011 world oil usage estimate to 89.3m barrels per day, up from 84.1m as recently as 2009 and its fifth demand upgrade in as many months.
In 2010, Chinese oil use grew by an astonishing 15.1% year-on-year, with the People’s Republic now burning more than 10m barrels daily. And given that China’s per capita oil usage is still only a fraction of Western levels, as the country’s massive population gets richer, overall oil consumption will certainly keep rising and could even accelerate.
So the “secular” growth story, driven by the emerging markets, has been driving up oil demand. At the same time, Western governments, not least in the US and UK, have been adding fuel to the fire by massively expanding their base money supplies under the guise of “quantitative easing”.
As soon as such extreme policies were adopted in early 2009, some of us warned investors would view them as “currency debasement” and react by swapping dollar- and sterling-denominated investments for “tangible assets”, creating an oil price spike. Such views, previously seen as heretical, have since been shown to be true.
Commodities and other assets governments can’t print more of are now being widely used to hedge against Western inflation and currency depreciation. Just as they are starting to recover from the credit crunch, consumers and businesses in Europe and the US will now suffer badly from a spiralling oil price. Well, to some extent, sky-high crude is a direct result of the grotesquely irresponsible monetary policies pursued by their own governments – which, along with the growing energy needs of the East, have stoked oil demand.
Against this strong demand backdrop, drama in the Middle East has sparked supply-side fears, too. When the trouble was limited to Tunisia and Egypt, neither of which are significant producers, concerns were about “contagion”. But Libya is a sizeable oil nation, pumping around 1.7m barrels daily. The Italian oil major ENI, which dominates Libyan production, says 1.2m barrels of production could be lost – possibly more.
At the same time, many of the European refineries that obtain their oil from Libya can only process light crude, a product even the mighty Saudi Arabia finds difficult to supply.
That’s not the only reason why assumptions that the West can rely on Saudi – holder of 25% of global oil reserves, and the world’s “swing producer” – may be wide of the mark.
The country’s ruling elite, with the monarchy at its heart, is clearly petrified that civic unrest, having now spread to neighbouring Bahrain, could engulf the Desert Kingdom. That’s why they’ve just unveiled a $35bn package of welfare payments to placate an increasingly dissatisfied population.
The reality is that, in the current climate, the Saudi authorities will want to avoid, at all costs, the risk of being seen as too “pro-Western”. During recent oil price spikes, Riyadh has been able to come to the rescue and turn the oil spigot. They’ve used the argument that high oil prices will ultimately derail the big Western economies and therefore undermine global oil demand – which will harm the Opec oil exporters cartel, not least its members in the Gulf.
Such logic is now far more difficult for the Saudis to sell – not only due to growing anti-Western sentiment across the Middle East but also because, given the burgeoning energy needs of Asia, traditional assumptions that the big oil producers need the economies of Europe and the US to remain buoyant no longer wash.
So this oil price spike, similar to its predecessor, might easily cause another Western recession. But it will be different in that it could also be the harbinger of a historic realignment of relations between the Middle East and the West. You see, even when economics seems to produce semi-scientific outcomes, the underlying realities are generally still driven by the vagaries of politics and the ebbs and flows of history.