Expensive Oil and the Economy

Finance at First Light
Good morning! Here’s what you need to know:


  • Oil Prices Hit $100 | Mideast contagion fear has sent crude prices to $100.
  • Might Endanger Economy | Some analysts say expensive oil could stop the recovery in its tracks; others aren’t nearly as worried.
  • Real Risk is Contagion | So far, the Mideast uprisings have affected only minor oil producers, but they could reach Saudi Arabia.



1. Oil Prices Hit $100

US crude hit a 28-month high of $100 yesterday as a lethal political standoff between Libyan strongman Muammar Gaddafi and rebel factions now in control of oil-rich eastern Libya has already cut output in the world’s 12th-largest crude exporter by more than 25 percent, or 400,000 barrels a day, according to Reuters calculations. “Oil prices are not likely to fall any time soon,” said Shelley Goldberg, commodities and energy strategist at Roubini Global Economics in New York.

Dave Kansas reported on the Wall Street Journal’s MarketBeat blog that Nomura Securities considers the current situation to be similar to the 1990-91 Gulf War, during which oil prices rose 130 percent in two months. Nomura says that if Algeria joins Libya in the current storm of social upheaval, oil prices could shoot to $220 a barrel. If anything, the firm thinks it “could be underestimating this as speculative activities were largely not present in 1990-91.”

Meanwhile, civil war has erupted in Libya. Early this morning, forces loyal to Gaddafi struck rebels in several cities surrounding the capital of Tripoli as the uprising moves steadily toward the capital and military officer defections multiply.


2. Expensive Oil Might Endanger the Economy

While many analysts are comparing the current rise in oil and gasoline prices with the one that occurred in October 2008, Stephen Schork of The Schork Report says there are big differences. Back then, “the energy bubble had already popped and the oil markets were trending lower” while now there’s no oil bubble yet but gasoline is already on the rise. Home values down 30 percent and gasoline prices up 10 percent makes a bad combination that gets worse when you toss in high unemployment. He notes that the US personal consumption expenditure (PCE) on energy, mostly gasoline, is up to 4.15 — “a value we have not seen since the summer of 2008 … and we all know how that turned out for oil bulls.”

US Treasury Secretary Tim Geithner disagrees, saying yesterday the “economy is in a much stronger position to handle” rising oil prices, and, “Central banks have a lot of experience in managing these things.” He thinks America’s financial system is “way ahead of any other major economy.”

James Hamilton writes that “events as they have unfolded so far are not in the same ballpark as the major historical oil supply disruptions, and are unlikely to produce big enough economic multipliers that they could precipitate a new economic downturn. They might shave a half percent off annual GDP growth, but I don’t anticipate a whole lot worse than that.” He thinks oil will begin to affect GDP at about $130 per barrel, but acknowledges the risk of geopolitical contagion in the Mideast.

Peter Foster agrees that, so far, the uprisings haven’t threatened a new oil crisis. First, the world’s a lot richer than it was during the 1970s crisis and therefore “less vulnerable to oil shocks.” Second, “Even allowing for the rise in oil prices in Europe back over $100 a barrel, real prices today are no higher than 30 years ago.”


3. What If Social Unrest Discovers Saudi Arabia?

Consensus is that $100 oil is fine, but much more expensive than that is bad, and the development that could bring much-more-expensive oil is the Mideast uprising spreading to Saudi Arabia. According to the EIA, Egypt and Libya combined produce just 2.9 percent of global oil production, but Saudi Arabia produces 11.7 percent.

Price projections for oil in a Saudi uprising range from $140 to $200 per barrel. Two factors that could help mitigate the spike are quick intervention by the United States — very likely considering the importance of Saudi oil — and a sharp drop in global demand as the price of oil rises, as happened in 2008.

Saudi Arabia’s ruling family is taking proactive measures to prevent an uprising. King Abdullah announced a $36B financial support program that includes a 15-percent raise for public employees, debt forgiveness for imprisoned debtors, and student aid. The government also pledged to spend $400B by the end of 2014 on societal improvements. Despite these steps, the Saudi public is demanding real change and a nascent movement calling for a “day of rage” on March 11 is gaining momentum.

Have a great day!
Jason Kelly
The Kelly Letter

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  1. Posted February 25, 2011 at 12:33 pm | Permalink

    Hi Jason,

    I definitely agree with you about the presence of strong and funded oil and coal lobbyists and the role they continue to play in maintaining our dependency on these “dirty fuels.” What are your thoughts on natural gas (from shale), particularly given its abundance and greener properties?

    Omar Halabieh

    • Posted February 25, 2011 at 1:32 pm | Permalink

      I’m bullish on nat gas as an alternative fuel, but have been watching for a bottom in its price for a long time. It just keeps falling because the supply is seemingly endless. Scarcity makes a far better investment than abundance. I continue watching the sector to find a balance between paying too much for an abundant commodity and arriving too late for the next phase of energy infrastructure. Nat gas makes a lot of sense as a way for America to reduce its oil dependency and harmful emissions at the same time.

      There’s more info on nat gas at the Dept of Energy.

  2. James Fan
    Posted February 25, 2011 at 1:12 am | Permalink

    In this world some countries make money with oil, some with cheap labor etc. What is our edge? Innovation. Who made the first car, the first airplane, the internet and Facebook? They all truly changed the world. We need something like that. MIT has a technology review, see the link below. One of its breakthroughs is in the field of biomedicine/genomics. New technology provides a way to study the human body and human diseases. Everybody needs medicine as much as oil.

  3. Carl Smith
    Posted February 25, 2011 at 1:04 am | Permalink

    Is this a condition that we have partially created by being dependent on oil, and by letting the profits from oil go somewhat unchecked, allowing those in control to exponentially grow in power and influence? I am not very interested in politics but it seems like an American move to use alternate energy may not stop mid-east turmoil but will soften the impact on economies.

    • Posted February 25, 2011 at 9:46 am | Permalink

      It’s a truism that vulnerability to oil price fluctuations arises from dependence on oil, so the answer to your question is yes. The political complications arise when you consider who exactly is vulnerable. What’s bad for the buyer isn’t always bad for the seller. High prices at the pump may cause complaints among the populace, but few in oil company boardrooms. Who pays politicians more, the populace or oil company boardrooms? The latter, of course, which is why there’s no rush in Washington to end oil dependency.

      We could be completely off oil right this moment if oil weren’t such a profitable business. Technology hasn’t been a barrier for several decades. Electric cars, even hybrid cars, were invented at about the same time as the internal combustion engine. The petro lobby has done a wonderful job convincing people that electric cars are futuristic; they’re actually old news. About 100 years ago, there were more electric cars on America’s roads than gasoline cars. The reason gasoline took off is that oil was discovered in Texas and long trips across America were not feasible at that time on existing batteries. That’s no longer the case for about 95 percent of driving needs, but oil remains the only option for drivers because it’s the most profitable business on Earth.

      The fix is known: All-electric cars recharged on a nuclear power grid. Powerful oil and coal lobbies, however, prevent it from happening — and don’t bother explaining climate change to them. They’re aware of it, but just pretend in public that the science is in doubt. There’s even a rough schedule in place to stop denying the science and start pretending to be working with enviro groups to find a cure, as if the cure is not known. Say what you will about the energy lobby, but don’t say it’s stupid. Its plan is to drag out dependence on its products for as long as possible, knowing that any environmental consequences of such lie so far down the road that those in charge today won’t be around to suffer.

      For more info on this subject, see Financially Stupid People Are Everywhere ($9.89 Kindle edition), written by one of my favorite authors. In Chapter Six “How Money Is Power,” pp. 113-123 examine oil dependency. It, along with health care spending and military spending, is looked at in terms of financial impact on citizens to show how people routinely vote against their own financial interests.

  4. Keith Padgett
    Posted February 24, 2011 at 10:52 pm | Permalink

    Jason, your articles and precise view of the markets around the world are invaluable! Keep up the great work!

    • Posted February 25, 2011 at 9:29 am | Permalink

      Thank you, Keith! Will do! I’m happy to have you onboard.

  5. Gregory Iwan
    Posted February 24, 2011 at 10:20 pm | Permalink

    It’s been somewhat amusing here in the USofA, hearing certain windbags who continue to criticize renewable energy, along with “bailouts” and “stimulus.” Some enjoy lumping all those together. Wind power simply cannot be “depleted;” maybe that’s why some don’t care for it. There’s no killing to be made from it. As for solar, same problem, PLUS there is no way to see geopolitical — er, difficulties — limiting or endangering its movement or use. All one needs to “worry” about are clouds and darkness. Would that the only political darkness were overseas.

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