Oil, Saudi 1 Rest of World 0

As the oil price hits 80 dollars a barrel, the recent rise is gaining a few comments this week and resurrecting the debate as to what point the higher prices could have an impact on growth. Rising oil prices can often lead to recessionary conditions on two fronts. Firstly, it’s a tax on consumption and secondly as it causes inflationary pressures forcing the central bank to raise interest rates. Sharply rising oil prices have predicated the five recessions since the end of the Second World War. Higher oil prices should also indicate something of a stronger underlying economy. The main reason the oil price has been recently rising is due to expectations of supply constraints.

The catalyst for the initial recent rise appears to be the sanctions the US imposed on Iran, the third largest oil exporting country in the world. Increased supply to compensate from other sources, for example, Saudi and Russia, have not been forthcoming so far. Sixty dollars is considered the ideal price for the global economy as it supports those countries who produce oil at those prices whilst not creating too much of a brake in economic growth.

The price of oil seems to create more sentiment swings even than the equity market. When the price was trading near 30 dollars a barrel in early 2016, Bloomberg had reports showing traders net short positions. We even wrote about it at the time. There were many reasons why the oil price would not recover. Falling demand due to technology changes, oil supply as again technologies enabled shale to be gas to be recovered more cheaply. Now the price has reached 80 dollars a barrel Sanford Bernstein, according to a CNBC report, have predicted the price could almost double from here. In the same piece, they quote some analysts who believe it could now rise to 200 dollars a barrel.

Moody’s Chief Economist Mark Zandi believes that every 10 dollars rise in the oil price reduces US economic growth buy up to 15 basis points. A rise to $150, would halve US economic growth, assuming growth at 3%. Not taking into consideration the additional interest rate and inflationary cost.

The Saudis appear to have played the oil price pretty well. They created a glut two to three years ago forcing the price down. This move impacted investment in the industry ensuring it was less ready to react to increased demand. They then slowly reduced supply as the global economy recovered managing the price back up to where it is now.

Posted on September 25, 2018 .