Oil prices – the Egypt factor

Oil price Jan11.png‘Budgeting for Uncertainty’ seemed the best title for the blog’s new White Paper. And already developments in the Middle East are suggesting this could have been a wise decision.
As the above chart of average annual oil prices shows, the 1970 oil price was just $1.80/bbl in nominal terms (blue dotted line), equal to $9.94/bbl in ‘real’ 2010 dollars (red line). Since then, there have been 4 oil price peaks:
• 1973-4 OPEC oil embargo which took ‘real’ prices to $50/bbl
• 1979-80 Iran hostage crisis took them to $96/bbl
• 1990’s Iraqi invasion of Kuwait took them to $39/bbl
• 2008’s Israeli threat to bomb Iran, led to $97/bbl
Now, Brent prices have moved back above $100/bbl, as unrest builds in Egypt and other Middle East/N African countries. Egypt is, after all, a key country in the region.
Sadly, this is a major ‘own goal’ for US policymakers. As the blog noted in the White Paper, the US Federal Reserve has been explicitly targeting higher asset prices, via its QE2 Lifeboat policy. Just 2 weeks ago, its Chairman, Ben Bernanke boasted that:
“Policies have contributed to a stronger stock market just as they did in March 2009, when we did the last iteration of this. The S&P 500 is up 20%-plus and the Russell 2000, which is about small cap stocks, is up 30%-plus.”
And, of course, this has also fed the ‘correlation rally’, raising the price of food and oil, and so led to growing political unrest amongst poorer people in the Middle East and other emerging economies. It now threatens higher oil prices, and regime change amongst governments friendly to Western interests.
Yet as OPEC’s secretary general, Abdalla El-Badri noted Monday, “the oil market is well supplied” with strong inventories, and “demand is less than last year” at this time. And, revealingly, he added that “I don’t see why we have this high price.”
What happens next is, of course, the key question?
• The most likely outcome is that the army will broker an orderly transition to a new government. In turn, this might lead OPEC to seek lower oil prices via extra production, to reduce the risk of further unrest spreading to other key states.
• But if there is instead a disorderly transition, then the rises seen since Friday might well continue, returning prices to the $100+/bbl levels seen in 2008.
As we cannot be certain which way events will develop, the blog suspects its July 2008 advice, in response to the Iran threat, may again prove helpful. It suggested then that “prudent CFOs and business managers might well wish to consider hedging their purchases and sales against both these possibilities“, given the problems that a major move in either direction could cause.

3 thoughts on “Oil prices – the Egypt factor”

  1. Paul
    Is this not a “Freakonomics” scenario, where the intended outcome of the US Fed actions is to stabilize the US, but in the end it tends to destabilize everything around us? Do you sense that Ben B and his crowd understand that this is happening?
    Thanks for your insights to our economy.

  2. Bart
    Many thanks for your comment.
    I think you have hit the nail on the head – this is not a deliberate policy outcome, but instead an example of the ‘Law of Unintended Consequences’.
    What Bernanke and his colleagues are missing is an understanding of the demographic shifts in the Western economy (https://www.icis.com/blogs/chemicals-and-the-economy/2011/01/new-normal-workshop-in-singapo/ ), which mean that central banks can no longer stimulate demand in the way that was possible when the BabyBoomers were in their 30s and 40s.
    I am convinced, as Kevin Warsh argued in November, that although Bernanke still sees the current problems as due to a lack of liquidity, they are really due to lack of solvency (https://www.icis.com/blogs/chemicals-and-the-economy/2010/11/warsh-calls-for-better-policie/ ).
    And unfortunately, if I am right on this, then his current policies, whilst totally well-intentioned, are actually making the real problem worse, not better.

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