Ladies and Gentleman, here we go again. The violence in Libya continues, and as the battle wages on the price of oil continues to spike up. According to Lazard Capital Markets, that spike is very reminiscent of the spike we saw in 2008, which contributed to the recession we are still trying to dig out of.
Oil prices likely to go higher but entering demand destruction range; time to get more cautious. In contrast to the 2008 superspike, where oil prices spiked on runaway emerging market demand, the latest spike has been driven by supply issues as Middle East instability worsens. With unrest spreading from Egypt to Libya and Oman (and concern over possible unrest in Saudi Arabia), we believe oil prices could go significantly higher from current levels. Our price elasticity models indicate oil prices could spike to $160+/Bbl if we lost all Libyan production and one half of Saudi production.
That said, we are near levels where the market begins to worry about negative impacts on the economy (~ 5% of global GDP), which we believe warrants a more selective investment stance based on our analysis of the prior oil price spike cycle in 2008.
Since this scenario is somewhat different, being based not on demand but on supply, it is unsure whether or not it will have the same impact. But if you’re looking at the oil price just in terms of GDP, we’re nearing the point where things could turn ugly.
It is true that this particular oil spike may be different than the one in 2008, but don’t forget that every rescission we have had since the mid-1970s has shown an accompanying spike in oil prices.
Economist Jeffrey Rubin said in 2008:
Curiously, an over-500% increase in the real price of oil gets virtually ignored as a culprit behind today’s economy, eclipsed by the ongoing crisis in financial markets. Yet the run-up in real oil prices this cycle is over twice the spike in oil prices that occurred during the first or second OPEC oil shock. And those oil shocks produced two of the deepest recessions in the entire post-war period, including the 1980-82 double dip.
The price of oil influences more than just how you heat your house or drive your car. Since most manufacturing uses oil in at least some of their manufacturing process, even if it just to get product to the market. Basic food items are already in an inflationary period, should it last this oil spike will make it worse. What may end up being similar to 2008 is that people will have to choice between bank payments and basic staple items whose costs were driven up by their energy costs.
So what is the Obama administration doing to retard the increase in costs? Tapping the strategic oil reserves. The supply of oil the country keeps in the event of a real emergency.