Oil Prices Threaten Recovery

While reported economic data suggests an ongoing recovery, there continues to be a rash of underlying problems which threaten to make any upturn short-lived.  We've discussed the deteriorating situation in the Euro-Zone, especially Greece.  Recently, another "bomb" has had its fuse lit - the sudden runup in oil prices.

Crude oil prices shot up to nearly $150 per barrel in mid-2008 before the financial crunch and deflation wave led to a several month crash to about $30.  At the time, the world economy ground to a halt while financial intermediaries like Lehman, Bear Stearns, AIG, Fannie Mae and a slew of banks all found themselves insolvent in the blink of an eye.

Since bottoming, crude oil has ground steadily higher and appears ready to accelerate to the upside.  This week, oil climbed to $87 a barrel, its highest level since October 2008 and prompted concerns that triple-digit crude was once again a propect in the not-so-distant future.

The latest surge seems to have been prompted by rising confidence in a global economic recovery, even if most traders and bankers are still cautious about supply and demand fundamentals.

Pricier oil and other key commodities, notably iron ore and copper, could ripple through the economy and financial markets, potentially triggering inflation and forcing central banks to lift interest rates from ultra-low levels.  This could force bond yields higher, but lower the attractions of equities.

A HUGE difference from last year is that then the oil price was rising against the backdrop of a weaker dollar. This year crude and the dollar have risen together. In other words, had the dollar been weakening, the price of crude would be MUCH higher.

Prices are as much an effect of the economic expansion as a threat to it.  China, the fastest-growing economy, is expected to consume 520,000 barrels per day more this year than last. China's growth in demand alone will make up 1/3 of the worldwide growth in crude demand.

Higher crude prices are starting to be felt at the pump.  Only a couple of months ago, gasoline prices were under $3.00 per gallon, but in many places are now within reach of $4.00 and may shoot higher as the summer driving season gets underway.

In Great Britain, gasoline prices are now £6 gallon.  This has lead to a significant falloff in demand and is an element in the declining pound and sluggish U.K. economy.

Adding further to fears are the recent escalation of tensions over the Iran situation, as more countries are prepared to impose sanctions.  A huge unknown would how Tehran might react to sanctions and the prospect of a military reaction given the growing suspicions that the country is now a nuclear threat.

Furthermore, recently, Iraq has shown signs of destabilizing and plans to develop Baghdad's huge oil fields might be in jeopardy.

Clearly, any Middle Eastern military confrontation would immediately send crude oil prices well into the triple-digit range and have worldwide economic ramifications.

In the age of "Peak Oil", any disruption of supplies will have grave effects on the tenuous global financial structure.

Marko's Take

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