The Oil and the Glory

The Weekly Wrap — March 2, 2012

The Weekly Wrap — March 2, 2012

Surging oil, but a paradigm shift in the U.S. economy: Against the drumbeat of steadily improving economic numbers, could the U.S. actually be on the cusp of a tumble back into recession and a greater geopolitical comeuppance? If you look at economic history, the answer is yes. Yet history may be changing, according to Citigroup oil analyst Daniel Ahn, with whom I exchanged emails this morning.

In a note to clients yesterday, Ahn (part of Ed Morse’s oil team) cites a high correlation between how much the U.S. spends on oil, and the onset of recession. The U.S. is right at that historical spending inflection at the moment — it spends 6.5 percent of its GDP on oil, smack between the 5-6 percent point at which recessions have resulted. "Historically, all but one U.S. recession since the Second World War was associated with an oil price shock. All but one oil price shock was followed by an economic recession," Ahn writes.

Yet, as we have been writing, many oil scholars believe we are witnessing a topsy-turvy realignment in the hydrocarbon world to which we have become accustomed. According to Ahn, the recessionary impact of oil shocks is changing with it: The U.S. appears to be much more resilient and able to withstand higher proportional oil prices. Only at 7 percent of GDP would oil spending — around $150-per-barrel oil prices in the U.S. and $175-per-barrel crude in Europe — trigger recession, Ahn told me. Among the reasons are that the U.S. economy requires less oil to produce the same GDP (a reduction in its so-called energy intensity), that Americans consume less and less gasoline, and that the country is on a ramp-up of domestic oil production. Ahn told me:

It’s a tremendous paradigm shift .. and it may be happening faster than originally thought. Nevertheless, it is small consolation to the driver facing $5 gasoline immediately.

Go to the jump for more on oil prices and the rest of the Wrap.

This does not mean that oil’s pivotal role in economic robustness has vanished. The U.S. crude oil bill remains "a primary concern for the sustainability of economic growth," Ahn writes.

The oil market is in an ultra-jittery state. There is the worry of Iran shutting the Strait of Hormuz in addition to a cascade of unpredictable additional events should Israel attack Iran. There is only a sliver of spare production capacity since Saudi Arabia has raised oil production to 11 million barrels a day, just shy of its claimed 12.5 million-barrel-a-day capacity. When there is little spare capacity, any unplanned event such as bad weather or a skirmish can incite oil traders to bid up oil prices. Just yesterday, oil prices soared to their highest level since the summer of 2008 — European-traded Brent rose by 5 percent, surpassing $128 a barrel — on a rumor of a pipeline explosion in Saudi Arabia (the price is down today now that this particular panic has subsided, Reuters reports.).

 

Why it is best if Iran sells all its oil, but at a discount: The Obama Administration’s current trajectory appears to be to cut Iran off as much as possible from the global oil market, and thus starve it of income to be used in the further development of nuclear capability. Yet that is not in fact Washington’s best course of action, not unless its aim is to mete out much greater punishment on itself and its allies than Iran will suffer. That is according to Trevor Houser, who runs the energy practice at Rhodium Group, a New York consultant firm. In a note to clients, Houser writes that the best policy would force Iran to discount its crude, but not actually pull it from the global market. That is because a loss of even 10 percent of Iran’s 2.3 million barrels a day of oil exports would be disproportionately felt by others, and less by Iran itself. If Saudi Arabia is unable to compensate for the lost Iran barrels, global oil prices could rise by as much as $16 a barrel. "That would reduce Iranian oil revenue by $2 billion per month, but raise global oil expenditures by up to 20 times that amount," Houser writes. The alternative is to facilitate discount purchases by China, India and others. He writes:

As economic theory suggests that shrinking the number of buyers of Iranian crude increases the negotiating leverage of those still at the table, allowing some countries to maintain, or even increase, the quantity of oil they buy from Iran might achieve the same policy objective at lower economic cost. If Tehran is forced to offer discounts to remarket crude to India and China that was previously destined for Europe, Japan or Korea, then sanctions reduce Iranian revenue without reducing global oil supply or pushing up global prices.

Official discounting is not the only way that Iranian oil can reach market. Another traditional way in such situations is smuggling: In the 1980s, South Africa defied a United Nations oil embargo through the good offices of smugglers Marc Rich and John Deuss; a 1989 U.N. investigation found that the volume involved was 200,000-280,000 barrels per day. In the 1990s, Saddam Hussain was smuggling between 70,000 barrels a day and 140,000 barrels a day against a U.N. embargo, according to a 1999 State Department report. Either way — through negotiated discounting or under-the-table smuggler’s fees — Iran’s oil income ($100 billion last year) could be reduced.

 

The coming collapse of U.S. oil prices: All is not lost in terms of managing to afford to drive. If you keep your eye on the horizon, oil prices actually are headed down, according to oil analysts. Take Deutsche Bank’s Paul Sankey and David Clark, who forecast $80-a-barrel oil in the U.S., or 26 percent lower than today’s trading level. At that price, gasoline would pull back sharply from their current levels. How do Sankey/Clark — and many other smart analysts — reach such a seemingly paradoxical conclusion at a time when at every turn another geopolitical crisis is tweaking prices higher and higher? Mainly because prices are going higher and higher. The Deutsche Bank team reasons that when European-traded Brent crude creeps close to $135 a barrel (about 8 percent higher than today’s price) — which they think will happen — consumers will start seriously cutting back. When they do so, they will create a surplus, and prices will fall (he expects Brent to decline to around $100 a barrel). In analyst-speak, here is how Sankey/Clark put it in a note to clients: "We believe that risk is sufficient in global oil currently for the market to be pricing to the point of demand destruction." No one can say with certainty when this scenario — if it plays out — will occur.

 

Putin’s six-year oil-reliant next term: Vladimir Putin seems certain to win a first-round victory in Sunday’s Russian presidential election. A mistake that many make is presuming that his current bout of anti-Americanism is an election ploy. Since he is all-but guaranteed victory, and requires no ploy, his rhetoric is better viewed as a window into how he plans to rule Russia after the election, as I say in the video below at the New America Foundation. Putin confronts an unpredictable Russian underbelly that — if it gets out of hand — could make his third presidential term quite uncomfortable. Rather than focusing on what he says he wants to do — diversify the Russian economy and rebuild Russia’s military — he would be distracted by battling critics in the street. In order to avoid this prospect, he needs to divert his people’s attention. Looking at his speeches within that framework, one can grasp why he has targeted the United States for virulent assault. Yet the U.S. needs Putin, or at least his vote on the U.N. Security Council when it comes for example to the global response to the Arab Spring. Behind closed doors, one suspects that Putin will be reasonable. But in public, expect him to stay on the time-honored course of anti-Americanism for some time to come.