"The Strongest Flashing Red Light Since 2008": Will Oil Shock Trigger The Next Recession?

When analysts talk about the biggest threats to the second longest economic expansion in US history that has sent the unemployment rate in the US to its lowest level in 18 years, the risk of a trade war often occupies a sizable chunk of the conversation. And now that President Trump has decided to slap Section 232 tariffs on metals imports from some of America's closest allies, we'll be hearing even more about the risks as academics and economists latch on to the notion that tariffs will harm the US economy (the same way Brexit would unleash a UK depression).

But while trade-war related risks have yet to materialize, the possibility that we're headed for - or are already in the middle of - an oil shock is looking increasingly more likely, despite numerous analysts and economists writing off rising oil prices as a non-issue (in a recent note about how rising oil prices will impact the Asian economy, researchers at SocGen played down oil price risks to both growth and inflation).

However, those ignoring the very real problems posed by climbing crude prices at this point so very late in the business cycle do so at their own peril, as David Fickling, an opinion columnist at Bloomberg, pointed out in a recent column.

But it's not just big bank strategists who are overlooking the risks of rising oil: the abovementioned SocGen energy analysts see oil price pressures receding in the near future as OPEC and Russia start to crank up production, pushing the price of crude lower. As it turns out, retail investors are also overlooking the risks, too.

As evidence, Fickling points to the number of web searches for the terms "oil shock" and "oil crisis". Judging by this trend, an oil shock would seem to be "the last thing anyone should be worried about"

NoWorries

And yet, as Fickling points out, the number of warning signs suggesting that oil prices are already having a very real negative impact on growth - particularly in Asia and South America - are rapidly increasing.

  • In Brazil, a strike by truckers protesting the price of fuel brought the economy to a halt over the past week, interrupting exports of soybeans, coffee and chicken and prompting some to call for a return to military dictatorship.
  • In India, prices for diesel and gasoline have hit multi-year records, leading to demands for the government to cut taxes and for a price cap to be imposed on state-controlled Oil & Natural Gas Corp.
  • Governments in Thailand, Vietnam and Indonesia and implementing or planning increases in retail fuel subsidies to protect consumers from the effects of rising oil prices and weakening national currencies.
  • Airline profits have probably peaked because of headwinds from fuel costs, according to Alexandre de Juniac, CEO of the International Air Transport Association. Philippine budget carrier Cebu Air Inc. this week promised to impose fresh fuel surcharges.
  • Moody’s Investors Service just blamed high oil prices in part for a 0.2 percentage-point cut in its outlook for India’s 2018 GDP growth, and warned of the potential of falling consumption spending and rising inflation across the globe if current high prices are sustained.

Meanwhile, as discussed on several prior occasions, the counterintuitive rise in the US dollar, and the tightening in financial conditions, that has accompanied the increase in oil prices has presented a double-bind for net oil importers in Asia and elsewhere outside the developed world - where investors are also coping with the inflationary shock of a depreciating currency. But the US economy is hardly immune. As a 2011 research paper written by James Hamilton at UCSD suggests, a spike in oil prices is an eerily prescient predictor of economic downturns - even if the increase isn't, relatively speaking, all that large relative to the recent past.

Take the first Gulf War. In the five months between Saddam Hussein’s 1990 invasion of Kuwait and the start of Operation Desert Storm, a spike drove West Texas Intermediate to an average $30.84 a barrel. Despite representing little more than a return to the status quo before Saudi Arabia flooded the market late in 1985, those prices were high enough to help spark the early 1990s recession.

As it turns out, "it's not the size of the oil shock, it's how fast you use it", or rather the speed at which it takes place. Hamilton's research shows that rapid jumps in oil prices have preceded 10 of the last 11 peaks in the US business cycle since World War II. The only exceptions were 1970, 1973 and 2003, which took place during - or just after - periods of recession.

Shock

By comparison, over the past 11 months, Brent is up 62% and WTI is up 46%. But how do we determine whether a move is sufficiently "rapid" to present a genuine shock? Hamilton's analysis involves comparing current prices to levels over the previous three years; this is what he finds:

Where prices are below their previous peak, any increase can be considered a return to the norm; where they’re above that level, there’s the possibility of a genuine shock. On a Hamilton-style measure, we’re seeing the strongest flashing red light since 2008.

Shock

In itself, that's an ominous signal but as Fickling notes, other signs of impending recession - the end result of any genuine shock - are looking more subdued. Still, Citi's global economic surprise index is at its lowest level in roughly five years for a reason... 

Global

Meanwhile, as we noted earlier SocGen analysts expect rising prices to have little impact on growth and inflation in Asia, a region that, due to its net-importer status (just 8% of global oil production is rooted in Asia), is often the hardest hit when prices climb, and particularly so when oil rises in tandem with USD. Their reasoning? Improving energy efficiency in China and elsewhere on the continent, combined with comfortably low inflation, suggest that a shock isn't imminent.

"Only if oil prices were to surge higher from here to $100 per barrel and sustain around that level for several quarters or more, would we start to worry," the team wrote.

But as Fickling counters, oil shocks are prophets - not partners - of economic downturns. This means that one shouldn't expect to see other signs of weakness until the shock has already taken root.

So unless supplies surge and prices ease sharply, and in the very near future to offset what has already been a remarkable "oil shock", the next downturn may already be a forgone conclusion.

Comments

dchang0 Mon, 06/04/2018 - 15:28 Permalink

Time to sell the SUV/truck and buy a Prius.

Never mind the fact that Priuses are actually less environmentally-friendly than regular gasoline vehicles; this is not about virtue-signally eco-consciousness--this is about making it through the next 5 years without getting destroyed by the monthly gasoline budget.

Buckaroo Banzai ZENDOG Mon, 06/04/2018 - 15:34 Permalink

Nothing to see here. Oil is headed back down to the $50-60 range. No way ZOG is letting Putin enjoy $120 oil. Plus, the marginal shale oil plays start becoming economic at $70+ so even if ZOG wanted oil at $120 there isn't much they could do about it. There is too much supply overhang in the US at that price.

In reply to by ZENDOG

TheWholeYearInn pods Mon, 06/04/2018 - 15:52 Permalink

Worst oil shock SINCE LEHMAN!

 

OT:

Virginia Congressional Candidate Admits He’s a Pedophile

https://www.thedailybeast.com/report-virginia-congressional-candidate-a…

 

"Nathan Larson, an accountant from Charlottesville running as an independent candidate in Virginia’s congressional election, has reportedly admitted to being a pedophile and bragging about spousal rape online.

 

In a phone call, Larson is said to have openly acknowledged operating the now-defunct websites suiped.org and incelocalypse.today—both of which reportedly hosted chat rooms for pedophiles and people with violent, misogynistic fantasies.

 

“A lot of people are tired of political correctness and being constrained by it,” he was quoted. Among numerous posts written under a pseudonym, Larson is said to have once suggested “every pedo” should impregnate a “pedo wife” to create “fucktoys.”

 

Asked whether he himself is a pedophile, he reportedly said, “It’s a mix of both. When people go over the top, there’s a grain of truth to what they say.” Larson, who has described himself as a “quasi-neoreactionary libertarian” candidate, also defended an essay about raping his ex-wife by claiming many women have rape fantasies, according to the report."

In reply to by pods

directaction Buckaroo Banzai Mon, 06/04/2018 - 16:48 Permalink

Oil production is on the very cusp of entering terminal decline. This will first result in higher prices, then crushed economies, and finally it will utterly destroy western industrialized civilization.

This three-step process will occur in the next three years and soon thereafter cause a severe population decline of at least 99% and quite possibly 100%.

We are on the very edge of the end of humanity. Be warned.  

In reply to by Buckaroo Banzai

shortonoil Buckaroo Banzai Mon, 06/04/2018 - 17:27 Permalink

"But as Fickling counters, oil shocks are prophets - not partners - of economic downturns. This means that one shouldn't expect to see other signs of weakness until the shock has already taken root.

 

So unless supplies surge and prices ease sharply, and in the very near future to offset what has already been a remarkable "oil shock", the next downturn may already be a forgone conclusion."

 

As petroleum production results in an energy producing process, an analysis of the energy dynamics involved concludes that Fickling is correct. That analysis indicates a strong preference for petroleum's deliverable energy to now go to the developed economies. The ongoing decline in emerging market currencies that is taking place is indicative that a downturn is now taking place in those economies. This has resulted because of reduced capital inflows to the emerging markets. According to the IMF capital flows to emerging markets has now reversed, and that there is now a withdrawal of capital from those markets of about $1 trillion per year. That capital flow is now being relocated to the developed economies, and it is providing support to maintain those economies. In the event that the price of petroleum continues to fall that capital transfer will reverse again, and weaken the developed economies by reducing capital inflows. If it stays at its present level demand from the emerging markets will decline. In both cases the economy will retract, but slower for the developed economies if prices remain elevated. In both cases a price shock will have occurred. The richest oil producing nation in the world, Kuwait, still has not fully recovered from the 2014 price collapse.

http://www.thehillsgroup.org/

In reply to by Buckaroo Banzai

dchang0 ZENDOG Mon, 06/04/2018 - 15:37 Permalink

Yeah, Ford's screwed.

They appear to have chosen trucks because they knew that new inventory of passenger cars are channel-stuffed on dealer lots for a decade, BUT they also had to have known that oil prices would go up due to insufficient new oil discoveries (see Art Berman and Chris Martenson's warnings that discoveries since 2014 have been insufficient to meet coming demand).

Rock meets hard place.

In reply to by ZENDOG

adr Mon, 06/04/2018 - 15:30 Permalink

Oil at $70 isn't the big deal, it is gasoline and other distillates priced like oil is $120 that causes economic problems.

At $120, gasoline will be $7.

Commerce starts to die when oil goes over $30. Proven by the Gulf War.

Also proven by the true economic depression that started around 2006 when the mass of retail bankruptcies signaled immense economic pain.

belogical Mon, 06/04/2018 - 15:32 Permalink

BS, the world is a wash in oil, they cranked up the price to suck up the tax cut Trump gave people. 

Put position limits on commodities, limit speculators to 10% of market and no greater than 3% max position. Problem solved.

Seeing Red Mon, 06/04/2018 - 15:40 Permalink

Maltese Falcon (where did he go?) said I/we would never see $70 oil again in our lifetime(s), so clearly a shorting opportunity (or just clickbait).

Rise Of The Machines Mon, 06/04/2018 - 15:42 Permalink

The S&P is trading at a P/E of around 25. Take a look back at 140 years of P/E history and see how often the S&P has traded above 25. Hardly ever, other than the dot com boom (biggest bubble ever) and when earnings collapse in the banking crisis in 2008/2009. So to be buying stocks here you presumably have to believe that something amazing is about to happen, such that 140 years of history no longer counts. Good luck with that.

ToSoft4Truth Mon, 06/04/2018 - 15:44 Permalink

Anyone recall a year or two back when the price of oil was falling??  The local serf were saying things like, "Oil has to go higher or we'll be in a recession". 

 

A refresher:

The Recession Caused by Low Oil Prices

" But this time oil prices have fallen more than 70% since mid-2014, while demand has been rising. The drop is entirely the result of America’s supply-side technology breakthrough with horizontal drilling and hydraulic fracturing—“fracking.” This has given consumers world-wide what amounts to a tax cut of $7.8 billion every day, or about $2.9 trillion over a full year. "

https://www.wsj.com/articles/the-recession-caused-by-low-oil-prices-145…

snblitz Mon, 06/04/2018 - 16:01 Permalink

If you want lower cost oil take a trillion dollars from the middle east wars and build 400 additional nuclear reactors at the existing US nuclear plants. Then you will get

  • $10 barrel oil
  • electrical energy independence
  • no more middle east wars
  • millions of lives saved (in the middle east)
  • 20 additional deaths per year due to expanded US nuclear industry
  • Save the planet from the evils of plant fertilizer (CO2)
  • lower cost energy makes US manufacturing more competitive
  • more to spend on things other than oil
  • help every poor person around the planet pay far less for fuel

I know, the world will end due to the "spent" fuel in the pools around the US.

That "spent" fuel had less than 3% of the potential energy removed from it.

Lookup 'breeder reactors' or 'nuclear fuel reprocessing'.  The US had two breeder reactors until Carter banned them.

The french have a bunch and laugh all the way to the bank reprocessing "spent" nuclear fuel.

Go look up deaths per gigawatt generated.  Nuclear is near the bottom if not the bottom.  Hydro is the biggest killer.

Low cost energy is what improves lives everywhere.  Stop being played for a fool.

You are simply buying into the propaganda of world oil producers and being sucked dry of your wealth.

 

LawsofPhysics snblitz Mon, 06/04/2018 - 16:20 Permalink

Lots of innovative things could be done if so much energy wasn't being wasted on WORKING TO SERVICE DEBT (CREATED OUT OF THIN FUCKING AIR BY A SELECT FEW WHO DO IT WITHOUT DOING ANY REAL WORK OR FACING ANY REAL RISK)!!!!!!!!!

FYI- oil producers actually have to do REAL WORK and face REAL RISK to extract that oil you stupid fuck.

You, like so many, ignore the 900 lb gorilla in the room!  DEBT/CREDIT/MONEY issuance!!!

In reply to by snblitz

SomeAreMoreEqual Mon, 06/04/2018 - 16:07 Permalink

Just like a predator culls the weak from the heard, so oil culls the weak from the economy...

The last crisis was due to many factors, but high oil prices seems to be the ultimate trigger that brought down the house of cards. Whether the price shock of oil does it again is questionable.

  • Is the economy as fragile as it was in 2007-2008?
  • Will oil hold out at highs long enough to trigger a meltdown?
  • Is market confidence such that people will stop expanding and hunker down?

I think these are questions that most of us do not yet know. But yes, oil could cause a meltdown. But I tend to think the fires will get hotter before anything goes that direction.

Truth Eater Mon, 06/04/2018 - 16:09 Permalink

We don't need to break $100 for oil to be a pinprick of one of the many bubbles.  We have debt, interest rates, international turmoil, domestic economic failure in cities & state, pension funds insolvent, desperation to prop up housing market.  That short move up to $73 may be just all that was needed.  I recall the price drop in 2008 followed by the crash.  Today we are worse off.