Global recovery is triggered by oil price shock

The disruption of Russian oil shipping, which includes the U.S. ban on imports that was announced Tuesday by President Biden, has been one of the most severe supply disruptions since World War II. According to Goldman Sachs, it represents the worst of all time. With other major oil producers unable or unwilling to increase output in the short run, the per-barrel price of Brent crude, the global benchmark, hit $128 earlier this week, up nearly 65 percent since Jan. 1.

After falling Wednesday on hopes for a negotiated settlement in Russia’s war on Ukraine, Brent slid further Thursday, closing just shy of $110. However, the possibility that oil prices remain high for the remainder of the year will reshape consumer spending and weigh on financial markets as well as straining government budgets across dozens of nations. This is going to feel quite grim,” stated Neil Shearing from Capital Economics, London. “It’s not going to feel like the Roaring ’20s.”

Rising oil prices effectively redistribute income from oil-consuming nations in Europe and China to producers such as Saudi Arabia, Russia and Canada. Shearing stated that producers spend less per dollar than consuming nations, which means higher oil prices can reduce economic activity.

The price jump since Jan. 1 — if sustained for a full year — would transfer more than $1 trillion from consumers to producers. This does not include gasoline, diesel and fuel oils. Higher prices in the United States are mixed. Drivers fumed this week when the average price of a gallon of gasoline surged to a record $4.32. The shale oil revolution made America one of the largest oil producers in the world. Higher prices increase oil companies profits and investors returns.

One oil stock index has gained 29 percent this year while the broader S&P 500 fell by more than 11 percent.

Still, Capital Economics says it would take oil prices of $200-plus to trigger a U.S. recession. One reason is that U.S. households together have an ample $2.5 trillion savings cushion, dwarfing the estimated $150 billion to $200 billion cost to consumers of higher pump prices, Ian Shepherdson, chief economist of Pantheon Macroeconomics, said.

Though Russia accounts for just 2 percent of the world economy, it is a major player in global energy markets. Russian wells supply 11 percent of global oil consumption and 17 percent of natural gas usage, according to Goldman Sachs.

Russian gas pipelines are critical to Europe’s economy, meeting 40 percent of European needs. Russian oil is transported to Poland, Germany and Slovakia from Russia. According to Goldman, this means that the impact of higher oil prices on Europe’s growth will be four-fold greater than it is in the United States. Economists believe that for now, the world’s economy should continue to grow in China, India, and the United States — which account for almost half of global output — in order for it not to fall into recession.

“It’s going to be significantly slower growth,” Shepherdson said. “Nothing like 2008 or the covid hit. But it’s going to be a marked slowdown.”

The outlook is clouded, however, by the possibility that Europe’s worst conflict in more than 75 years could spill into a more damaging war at any time.

Predicting the future of Russian oil sales — and global prices — is especially hazardous. If U.S. allies in Europe overcome their economic worries and agree to a complete embargo on Russian energy, oil prices could hit $160 a barrel, according to Capital Economics. Bjornar Tonhaugen, an analyst with Oslo-based Rystad Energy, told clients this week that oil could hit $240 this summer in a worst-case scenario, according to a Bloomberg report.

Reaching those stratospheric levels would require more comprehensive energy sanctions than have been imposed so far. The United Kingdom stated that it would stop importing Russian oil by the end of this year. The European Union announced a plan to cut its Russian gas purchases by two-thirds before 2030 and said it will take unspecified steps to eliminate oil and coal buys as well.

” We must be independent of Russian oil, gas and coal. Ursula von der Leyen, President of the European Commission said that we cannot depend on any supplier who threatens to harm us.

Traders at French companies TotalEnergies and other foreign firms are shunning Russian crude oil, even without any additional government intervention. Neste, a Finnish refiner has stated that it switched to non-Russian crude oil sources. Fear of falling foul of the allied sanctions against Russia caused China’s two largest state-owned banks not to fund new Russian oil purchases.

This “self-sanctioning” could idle 3 million to 4 million barrels a day of Russian oil, roughly 70 percent of the country’s total crude exports, according to the Oxford Institute for Energy Studies. Keeping that much supply off the market could add $25 to the cost of a barrel of oil.

Oil prices, which hovered around $65 a barrel in early 2020, traced an extraordinary arc over the past two years. In the coronavirus pandemic’s first months, prices actually turned negative as a glut of oil left traders offering to pay storage facilities to take supplies. As the economy has grown, prices have risen steadily over the last year.

It is unlikely that Russian barrels will be replaced easily. Moscow demands that Iran’s trade with Tehran is exempt from all financial sanctions. This has impeded Iranian exports. Before they can fill this void, Venezuela’s deteriorated facilities will need to be renovated.

Near-term prospects for higher U.S. production are likewise limited. Wall Street is also uninterested in funding increased oil production, despite being burned by the recent oil crisis.

Although the number of oil-rigs currently in service has increased steadily over recent years, it remains nearly one quarter below levels pre-pandemic, Baker Hughes (a Houston-based company that provides oil field services), said.

“If this continues to escalate, we are looking at the ’70s,” said Robert McNally, president of Rapidan Energy Group in Washington. “It’ll impart a sustained, grievous blow to the economy.”

Europe will be hit hardest. On Thursday, the European Central Bank acknowledged the war would have a “significant negative impact” on the euro-area economy and cut its 2022 growth forecast by half a percentage point, to 3.7 percent.

There are other private estimates that look even worse. Goldman Sachs stated Thursday that the euro-zone’s output would shrink in its second quarter. Eric Winograd, a senior economist at AllianceBernstein, puts recession chances at better than 50 percent. Some see rising energy prices pushing Europe dangerously close to the edge.

“Yes, growth can be positive, but it does a lot to the rebound from covid,” Sergi Lau, deputy chief economist at the Institute of International Finance said.

Central bankers have tended to ignore oil price fluctuations, viewing them as temporary influences on prices. But with U.S. inflation at a 40-year high of 7.9 percent, and labor market conditions tight, the Fed is almost certain next week to raise its benchmark lending rate by a quarter point. In response to Thursday’s inflation news Biden accused rising oil prices of “Putin’s price rise” – one of the four times that he named-checked Russian President Vladimir Putin. This was in a five paragraph statement.

Higher oil prices could cause the Federal Reserve to move less aggressively on its rate-hike campaign, Goldman said earlier this week. Jerome H. Powell, Fed Chair, faces a difficult challenge. He has to cool down the most inflation since decades, even though economists predict it will fall over the course of the year. And he must do so without tipping the $23 trillion U.S. economy into recession. The balancing act in Europe may prove more difficult, as the country’s economy started the year with less momentum and consumer price inflation has reached its highest level since the introduction the euro currency. On Thursday, investors were surprised when the ECB announced that it was speeding up plans to pull its financial stimulus. It stated that it would reduce its bond purchases starting in May, and then consider ending them by summer.

Eurozone inflation reached 5.8 percent in the last month. The Ukraine war poses a “substantial upside risk” for price stability, Christine Lagarde, President of ECB, told reporters in Frankfurt.

Many emerging market central banks, including Russia, Brazil and Mexico, have increased borrowing costs over the past months.

As the Fed tightens, central banks in many emerging markets — including Russia, Brazil, Mexico, Pakistan, and Hungary — will feel pressured to increase borrowing costs again, even though they are still recovering from pandemics.

According to World Bank estimates, current oil prices may cut by a full percentage point economic growth rates of major oil-importing nations like South Africa, Indonesia, South Africa, and Turkey. This would reduce South Africa’s prewar growth by half and Turkey would lose about 4 percent. China and Indonesia, on the other hand, would experience a drop in growth.

Governments in countries like Jordan, Lebanon and Tunisia, which protect consumers by subsidizing electricity prices, will struggle to afford those escalating costs. In January, Fitch Ratings warned that efforts to reduce fuel and utility subsidies “could spark social and political instability, particularly in Tunisia,” where the 2011 Arab Spring protests began.

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