The end of cheap oil?

The oil price may be about to soar, at the very least the events in the Middle East will have some effect. A Macquarie Equities report notes that worries about oil and gas transition through Egypt has turned into more concrete disruptions of supplies from Libya, which exports one third of the world’s spare capacity.

The period of low oil prices after the GFC may be about to come to an end, reviving fears of a revisiting of predictions that the price will go above $US200 a barrel, which Goldman Sachs shopped around in late 2008 (before the collapse of Lehman Brothers almost undid the world banking system).

The overall picture is anything but stable. Algeria and Libya are looking rocky, Iraq and Iran have known risks, but neither is reassuring, and Saudi Arabia may be less solid.

As Macquarie notes, if Libya or Algeria falter, the market may move towards scarcity pricing rather than looking at supply demand balances (which are murky at the best of times because of supply obfuscation). That could easily mean an oil price well above Macquaries target average of $US120 a barrel.

The Middle East unrest may be the key event that ends the era of cheap oil. Oil production has been running ahead of the annual discovery rate for about 25 years. Global consumption is about 32 billion barrels a year, discoveries average 5-7 billion barrels a year. Mexico, Norway, the United Kingdom, Indonesia, the United States and Russia are in decline, although this is partially offset by increases in Brazil, China, Angola, Azerbaijan, Kazakhstan and Qatar.

If the oil price starts to rise, there will be the usual concern in the markets about inflation, rising interest rates and equity market weakness. Inflation (which, as economists’ keep telling us, reflects expectations) did not rise appreciably when the pre-GFC oil price rises occurred.

The global economy is a lot more complex and adaptable than it was during the stagflation of the 1970s. But if a higher oil price does contribute to inflation, it will put developed economies’ central banks, which are running extremely low interest rate environments, into a real bind.

For investors, energy stocks are worth perusing.

Macquarie (1)

Comments

  1. Good post but I still am skeptical of regardless of what happens in the real world out there, our leaders in ivory towers will find any substantial inflation in their properitary “Core Measures”.

    What everyone seems to be ignoring at this stage with this $200 hype (except for some exceptional commentriat such as Rosenberg as highlighted by H&H), is the simple question what does $200 oil mean? It’s all good until the impact of it filters through to economic indicators (i.e. lags) and then we have rubbish statements from Central bankers that this could not have been expected as assumptions were that underlying economy was more robust!!

    On a side note, even BP’s back in business partnering with Relaince in a $2.5 billion deep sea exploration program (long term investment of $20 billion). 9 months later Bp’s warchest of power prooves the experts predicting their bankruptcy with probabalistic measures look like idiots!