Yesterday the Brent has traded above 100 dollar again. This is its highest level in 28 months. The first time that the oil price broke above 100 dollar was on the 28th of February 2008. It was then followed by a speculative craze that pushed the Brent price all the way up to 146,08 dollar per barrel. By that time oil demand in the US, the key oil consuming region, was going down. More and more US citizens defaulted on their mortgages and one of the reasons for this was the derailing fuel budgets. It is clear that rising fuel prices and their consequences for other commodities such as food was one of the reasons for the 2008 financial crisis.
This time, the consequences for European consumers of oil products and oil-indexed natural gas are even more severe than in 2008. Back then, the euro was worth 1,5121 dollars whereas now its value has declined to 1,3692 dollars. This means that in euro, a barrel of crude oil is now more than 10% more expensive than in February 2008.
There are parallels to be found with the situation in 2008:
- The underlying fundamental is similar: the 10% growth rates of emerging economies, foremost China, sucking up commodities faster than production can grow.
- It’s not only oil that is rising, metals, coal and soft commodities are also contributing to general inflationary pressure.
- Analysts’ hysteria is contributing to the bull run. This morning already you can read plenty of articles of enlightened minds that “forecast” even higher levels.
- Opec claims to have spare capacity but refuses to bring it to the market, saying that there is more than enough oil in the market.
- The contango in the market has almost disappeared and turned into backwardation, meaning that the further you go into the future, the cheaper the price at which you can buy oil. To some, this is proof that the bullish sentiment is unsupported.
However, we also see two important differences:
- In February 2008, we crossed the hundred dollar barrier at a moment of solid economic growth in all parts of the world. This time, we cross it at a moment of fragile economic recovery in the Western world. The traditional medicine for curbing inflation is raising interest rates. Governments hope that this will inspire citizens to save more and spend less and companies to invest less. This would obviously reduce demand for commodities and can stop the bull run. But on the other hand, it would also kill off the beginning of a recovery that we have seen in recent months. Moreover, it’s not only governments in the West that fear inflation. Authoritarian regimes across the globe know that many revolutions have started with a middle class that reacts to a rising cost of life. It is therefore not surprising that the Chinese government is taking steps to reduce inflation. But it is clear that these steps will reduce growth in China, the growth that has been the engine of recovery in many other parts of the world, as far as Germany. The Chinese government can see good examples of the danger for the regime of inflation happening before their eyes in the Arab world. The people on the streets of Cairo quote rising food prices as one of the reasons for their anger.
- This brings us to the second danger. Geopolitical tensions have always been cited as a reason for oil price increases. But if you look back in history, you can find only two occasions of serious oil price inflation due to political conflict. The first one was in 1973 with the Yom Kippoer war and the ensuing blockade of the Suez Canal. The second one was in 1979 with the Islamic revolution in Iran. The Gulf Wars for example, had only a limited effect on oil prices as Saudi-Arabia stopped initial price increases by pumping up more oil. Opec is now claiming again that it will open the valves if the Egyptian crisis would cause restraints to the world’s oil supplies. However, the current situation bears some very uncomfortable analogies to the two previous occasions of politics leading to oil supply crunches. There is a danger that if Hosni Mubarak is ousted, he will be replaced with a regime that is much less friendly with Israel. It might even be an Islamic government. War between Egypt and Israel would disrupt supplies through the Suez Canal. Fear of this scenario was the reason most cited for yesterday’s push above 100 dollar.
Overall, and as always, the picture for the next months is complicated and unpredictable. Mister Mubarak might survive the crisis. He might be replaced by mister El Barradei who seems to be a peaceful figure (he has a Nobel prize on his desk to remind him of that). I have read in many books and articles that the Egyptian Muslim Brotherhood has developed more in the direction of Turkey’s moderate Islamic party than in the direction of radical Islamism. It is clear that no one can predict what will happen in Egypt. And even if Egypt becomes a broader conflict with ramifications for oil supplies, it is not clear whether oil prices can continue to rise. My best guess is that it will cause a new recession as governments raise interest rates and middle classes see higher commodity prices cutting into their buying power.
The economic picture of the past decade looks really bleak. A large part of this planet is growing towards a better future by growing their economies rapidly. This leads to spectacular boom phases. But the planet is unable to support that growth with sufficient commodities. The consequence is high inflation cutting into buying power which leads to spectacular busts. There is a shimmer of hope however and it lies in the third difference with the situation in February 2008. This time, many gas consumers in the West are not affected by the rising oil price. They buy gas in the Hub markets. In Europe, these prices haven’t risen much higher than 20 euro per MWh even in the coldest winter in decades. In the US, prices are half that thanks to the shale gas boom. The developments in the gas market show the way out of the boom and bust cycle. We have to reduce our dependence on scarce commodities such as oil.