Just when the global economy was beginning to see the light after the deep recession of the covid, the clouds accumulate again on the horizon with the dark tone that usually precedes the storm. The invasion of Ukraine by Russia and (and those to come) have unleashed a new oil crisis (and raw materials in general) that threatens to stifle economic recovery and plunge the world into a new recessionary stage. Unlike the 2020 crisis, this recession could be accompanied by in recent decades, generated by the scarcity of raw materials and problems in the supply chain.
Modern history seems to support this hypothesis. Except for the covid crisis, which was triggered by a virus and the subsequent lockdowns, the rest of the last major recessions have been preceded Now, even the yield curve is starting to show alarming signs.
Luca Paolini and Arun Sai, strategists at Pictet AM, explain in a note that “clearly and in the short term the biggest risk is an increase in inflation due to interruptions in the supply of Russian oil and gas, which would lead to a significant loss of economic momentum. and potentially a recession. The barrel of oil is already close to 130 dollars per barrel, maximum of 2008.
Oil reaches alarm levels
This expert has done an analysis that shows that every time the price of oil rises 50% above trend, like now, there has been a recession. “You have to keep in mind that even though the world is less dependent on oil than it was a generation ago, it still makes up a substantial portion of global GDP, driving inflation expectations and weighing on consumer confidence.”
In addition, this time there is one more aggravating circumstance: (it delays investment and consumption decisions) and a general rise in almost all raw materials whose production is highly concentrated in a few countries and hands. The impact for the West, especially the Eurozone, is similar to that of a notable increase in taxes.
Why oil can derail the recovery
The extra income from more expensive oil is concentrated in a smaller number of countries and, above all, in a smaller number of people, who also tend to have high net worth (large Saudi, Russian fortunes…). These agents have a lower marginal propensity to consume than the people who benefit from the drop in crude oil, such as consumers in the West (including companies) and emerging countries that do not produce oil.
This means that each euro that these people save by filling the tank of the car or paying for heating fuel (after a drop in oil) is used to a greater extent for consumption. However, the extra euro earned by Big Oil and the people behind them is less useful in this regard. The benefits of more expensive oil are concentrated in a few people, while those of a fall are shared between millions and millions.
A commodity crisis
With these data in hand and also putting the rise in other raw materials into the equation, Rabobank economists warn that the arrival of a recession is gaining ground by leaps and bounds. , gas at all-time highs, cereals do not stop rising… These experts have published a report in which they simulate two scenarios (A and B): the first (A) speaks of a brief and disturbing war, which causes interruptions in world trade for up to six months, with significant falls in EU-Russia trade in particular.
Impact on GDP of the different scenarios
In this scenario, investment premiums (risk) increase moderately. Energy prices, including gas, rise sharply (oil at $125 a barrel), but fall after four months. Food prices are also up sharply, with wheat bouncing 30% and corn 20%, as are fertilizer prices (20%).
This scenario weighs on growth, but does not completely derail the global recovery. The problem is that this scenario is already almost a reality and now everything indicates that the situation is going to continue to get worse and look more and more like scenario B or even return to scenario C (it was not planned at first) that leads to a recession combined with heavy doses of inflation:
Scenario B (‘war and effective sanctions’), starts like scenario A, but also assumes that the US, the EU, Australia, New Zealand, Japan and South Korea impose effective sanctions on Russia by disrupting world trade patterns. As a consequence, energy prices rise more sharply and remain high for much longer. Food and vegetable oil prices also rise more sharply in this scenario. The risk premiums of some assets are also out of control. Unfortunately, right now it seems that we are closer to this second scenario.
“Given the current situation, it could be said that we are already in scenario ‘B’, not ‘A’. The direction that the situation is taking is also worrying. This means that the economic pain could be severe: there will be even more inflation and GDP growth will be depressed for longer. The impact will be felt by those imposing sanctions, as well as Russia. In addition, the risks now are of a further shift to even larger shocks that could lead to a ‘C’ scenario: secondary sanctions to the evasive countries that try to help Russia. The impact of this scenario is so severe that it is not even quantifiable”, assure the economists of the Dutch bank.
what the story says
Today, commodity prices have risen considerably more than during some of the major historical supply shocks. It must be remembered that many of these shocks have led to recessions. One of the most important shocks occurred after the Yom Kippur War in October 1973 and the second oil crisis in 1979, after the Iranian revolution. Both were the prelude to two deep recessions that occurred in an inflationary environment.
That decade was marked by recession and he reached double-digit highs. Especially bloody were the inflationary peaks of 1973-1974 and 1978-1980. Both knocks had common protagonists and similar to today, oil and war scenario.
Evolution of raw materials
The first of these, that of 1973, better known in the media, was caused by the embargo imposed by OPEC on several countries, including the US, in retaliation for its support of Israel in the Yom Kippur War. This caused the price of imported crude oil to quadruple in just a few months. US President Richard Nixon asked gas stations not to sell fuel on Saturday or Sunday nights and refueling restrictions were established in the country according to license plates (even and odd).
In Europe, a Sunday driving ban was enacted in the Netherlands, while the UK imposed a three-day business week as coal shortages threatened electricity supplies. Families were even asked to heat just one room in their homes.
At the second peak, the spike in energy prices in 1979 had its origins in the political turmoil in Iran earlier in the year. The ensuing supply disruption, coupled with desperate efforts to build up stocks, led to chaos in the global oil market and a rapid spike in spot market prices in the second quarter. OPEC followed up with a series of price hikes in April, July and December. In 1980, the war between Iran and Iraq caused a further decline in production.
For Bank of America (BofA) economists, the first conclusion is clear: In a note to clients published at the end of last week, they point out that 2022 is being the strongest start to the year since 1915 (World War I) for prices of raw materials with the highest price of all time for coal and aluminum, and the highest since 2008 for oil and the price of wheat. Oil in Russian rubles has doubled in the last 12 months, they add.
His second conclusion is that “war is stagflationary.” “The Yom Kippur War and the ’73 oil shock were bad for Wall Street. Only commodities outperformed inflation, the S&P 500 is down 40% from its peak, technology, consumer, banking and small capitalization were hit”, they indicate. “The Federal Reserve tightened policy but oil prices did not reverse in ’74, they remained structurally high despite the cessation of hostilities. The bear market/recession ended only once the Fed reversed course, cutting the rate of Fed funds from 14% to 3%,” they add.
How far can oil go?
Going deeper into the comparison with the 70s, the economist Juan Ignacio Crespo tries to calibrate the current rises in oil with those of that historical stage. “Since the oil supply shock of 1974 (due to the Yom Kippur War) and the subsequent one in 1979 (due to the Iranian revolution), there has not been a start to the year comparable to what is happening in 2022,” explains the expert. citing a double phenomenon as the cause: Firstly, after the 13-year downward price trend that lasted from 2008 (although it took the direction more clearly in 2011) until 2021″. Secondly, “the war in Ukraine, which It has exacerbated this upward trend in the price of raw materials that began after the closure of the economies due to the pandemic.
The economist calculates the rise in the price of Brent oil from December 31, 2021 (+52%). With the close of last week, he confirms that it has exceeded the rise in the same period of just over two months at the beginning of 1979. Despite everything, the revaluation of Brent oil is still far from what it had in 1974.
“Until now, seeing that the rise in the price of Brent had been similar to that of 1994, first, and that of 2021, later, we had made the forecast that a barrel of Brent would reach 128 dollars. But, if the resemblance with 1979 being maintained throughout the year, we would be doomed…
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