Like sands through the hour-glass, these are the fears of our lives. Just as we noted last week [13], the focus of risk is shifting from Greece (where while 'tail-risk' has perhaps receded for now, it is all-but certain that the insolvency predicament will resurface as a source of political, policy, and market tension in the not-too-distant future) to other foot-holds on the growing wall-of-worry. As UBS' Larry Hatheway notes this week, several candidates may replace Greece in the risk headlines, among them rising bond yields, French elections, or a Chinese hard landing. But his sense, and ours, is that oil prices will become the next risk item for market participants. Partly this is because oil prices are already approaching levels where worries have occurred in the past (and the velocity of the move is also empirically troublesome) and partly as the remedy for all global-ills (that of central bank printing) is implicitly impacting this 'risk' in a vicious circle. With global growth expectations already low, the 0.2ppt drop in Global GDP for each $10/bbl rise in oil will do nothing for Europe and US hope - and leaves Central Banks in that dangerous position of reinflating their low core inflation data while all around them is inflating rapidly. With modest schadenfreude, we remind readers of our comments from last week [13]: "Alas, as noted previously, the central bank tsunami is only just starting. Watch for inflation, and concerns thereof, to slowly seep into everything". Given oil's potential 'real' impact, as SocGen notes: "Perhaps Greece wasn't so bad after all."
[14]
UBS: After Greece, Oil
Of course, it matters what is driving up oil prices. This year, crude oil prices have tracked the upward trend in our global growth surprise index (Chart above). To the extent that rising prices reflect stronger growth, price increases can be sustained—up to a point. For oil consuming countries, rising prices will begin to crimp purchasing power. And although oil producers reap a windfall from higher revenues, their propensity to spend is modest. So although rising oil prices redistribute income, they don't proportionally redistribute expenditure. In short, rising oil prices boost global savings and depress global demand.
Based on results derived from simulations on large-scale macroeconomic models, global GDP falls by about 0.2 percentage points for every $10/barrel increase in oil prices, assuming the price rise is sustained for a full year. The impact is somewhat less for energy-efficient Europe, but larger for many emerging economies where the energy-intensity of GDP is relatively high.
To be sure, oil prices haven't been rising for that long. Still, with global growth forecasted at only 2.8% this year (a forecast based on an assumed average annual WTI oil price of $98/barrel), even small reductions in growth are worrisome. Also, with corporate profit margins already at peak levels, decelerating sales growth poses downside risks for already-flat non-energy corporate earnings growth.
Still, as noted, rising prices thus far appear to reflect better-than-expected growth. The big risk, therefore, is a disruption to supply. The leading candidate is Iran, given rising tensions over its nuclear program. That evokes memories of last year's oil price spike following the war-related disruption to Libyan supply.
A sudden stop to Iranian production would be more severe than the fall-off in Libyan output. Prior to last year's strife, Libyan oil production stood at 1.6-1.8mln barrels per day. The hostilities caused a collapse in Libyan output and exports, which have since recovered to about 1.0mn barrels/day (UBS
estimates). In contrast, Iran is the world's fifth largest producer of crude oil (2010 CIA estimates), although its production has recently dipped somewhat.
According to the latest estimates from the International Energy Agency (IEA), Iran produces just under 3.5mn barrels/day (from a peak near 4.2mn barrels/day), of which about 2.5mn barrels/day is exported.
According to the IEA, idle world oil production which can readily be made available in the event of a supply disruption is about 2.5mn barrels/day, almost precisely the level of Iranian exports. In short, if Iranian supply falls away, the world won't have much (if any) short-term spare capacity to make up any other shortfalls. That is important, given possible disruptions to supply in the Persian Gulf or to shipments via the Straits of Hormuz if military conflict with Iran breaks out.
We can't judge the risks of an escalation of tensions with Iran, much less the probabilities of a military strike against its nuclear facilities or any military response of its own to Mideast oil supply/shipments. But it seems reasonable to assume that in the event of such outcomes, crude oil prices would jump sharply from already high levels. And with little visibility about how long global oil supply would be at risk, we think it is fair to assume that in such a scenario investors would rapidly discount the risk of global recession, accompanied by collapsing corporate profits.
Perhaps Greece wasn’t so bad, after all.