Energy Expert Warns Oil Shocks Hit The Economy With Incredible Speed, Usually Within Thirty Days

Submitted by Steven Kopits of Princeton Energy Advisors

The lasting damage from the weekend’s attacks on Saudi oil infrastructure is yet to be fully assessed.  Having said that, we can make some broad statements about supply outages and economic cycles.

Although we tend to forget it, almost all of the major US recessions since 1945 have been triggered by wars in the Middle East involving Persian Gulf countries and oil politics.

Specifically:

• The 1956-1957 Suez Crisis led to the closing of the Suez canal and rapidly precipitated a recession in the advanced economies
• The Yom Kippur War of 1973 led to an embargo on oil exports to the US and other western countries, precipitating the first US post-peak oil shock
• The Iran-Iraq War created another price spike, triggering the Second Oil Shock, two back-to-back recessions in the US (1979-1983)
• Price increases associated with Saddam Hussein’s preparations for the First Gulf War tipped in the US into recession in 1991
• The Arab Spring of 2011 created supply shortages which sent oil prices back over $100/barrel, leading to a two year recession in Europe

In recent times, only the 2001 Dot.com bust and the 2008 oil price spike were not associated with supply outages related to a conflict in the Middle East. A conflict-induced recession would not be an exception to the rule, but rather the typical trigger ending a late stage expansion in the west.  

Oil shocks hit the economy with incredible speed, usually within thirty days.  

The magnitude necessary to precipitate a price spike and a resulting recession is probably less than a loss of 3 mbpd, 3% of global supply.  Over the weekend, Saudi outages totaled 5.7 mbpd.  The oil price would have to reach around $110 / barrel to push the world into recession, before taking into consideration the phase of the business cycle.  The closest parallel is 1991, when a brief oil price spike pushed an already tottering US economy into recession.

The futures curve as of this morning can be seen on the graph below.  At present, it appears to represent no major risk to the global economy.

We had earlier stated that the administration’s ‘maximum pressure’ strategy on Iran enhanced the attractiveness of a lose-lose scenario for Tehran. That is, if Iran could not export across the Strait of Hormuz, no one would.  We take the current attack to represent yet another step up in this lose-lose mentality, that is, Iran is hoping to force the US back to the bargaining table while employing tactics which can only be described as fatalistic and self-defeating.

At this point, it looks like the die is cast, and the situation is more likely to deteriorate than improve, perhaps materially so.