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Here’s what happens if the oil rally turns into an ‘oil shock’


The global oil benchmark flirted with the $80-a-barrel level again on Tuesday, underlining concerns that an unexpectedly strong crude rally could eventually begin to weigh on economic growth.

The combination of renewed U.S. sanctions on Iran, potential sanctions on Venezuela, a rising geopolitical risk premium, strong demand and other factors have made talk of $100 crude sound less outlandish. Indeed, some analysts argue that the backdrop now leaves the market more open to potential price spikes.

So what if oil did climb back to triple digits for the first time since 2014? Economists led by Arend Kapteyn at UBS laid it out in a wide-ranging note on Tuesday.

In it, they observe that the rise in Brent LCON8, -1.27% from around $60 a barrel a year ago to close to $80 makes for the 11th largest price spike (see chart below) in 70 years (crude’s initial 2017 jump ahead of a February pullback was the 10th largest). West Texas Intermediate CLN8, -1.63% , the U.S. benchmark, was trading below $73 a barrel Tuesday afternoon.

They note, however, that $80 oil today means “something very different than it did for our parents.” Measured in constant dollars, the spike, while large, is smaller than the spikes that preceded past recessions. Moreover, the world is more fuel efficient, which means the world needs fewer units of energy to produce one unit of gross domestic product.

For the U.S., there is also the matter of the shale revolution, which has propelled the country back into the top ranks of global producers. The U.S., however, does remain a net oil importer. The UBS economists go into detail:

The US is still a net oil importer, even though the oil balance is rapidly improving. In theory that should mean that higher oil prices lead to a transfer from consumers to domestic and foreign producers. The domestic transfer is in principle neutral from a growth perspective if volumes are unchanged (domestic producers gain what consumers lose), but because of the additional transfer abroad, the net impact on growth is negative. However, volumes are not necessarily constant, the move in oil prices from below $30/bbl up to where we are now has brought with it a surge in equipment and structures investment as well as substantial employment gains. As a result of this investment, US production surged from about 9.6 million barrels per day to over 10.7 million over the last six months. Once you factor those effects in the growth effect for the US becomes net positive. There are, however, threshold effects (and that GDP elasticities are not constant): the volume effects on the production side depend on where spot prices are vs break-even prices; at current oil price levels we assume the incremental production brought on line starts to diminish.

If the U.S. is included among oil producers rather than consumers, the UBS model finds that a 10% oil price rise leads to a weighted average GDP growth increase of 15 basis points, or 0.15 percentage point, for producers and a drag of 9 basis points for consumers. Since consumers have a larger weight (66%), the two roughly cancel each other out, leaving only a 1-basis-point net drag on global growth.

They found, however, that a $100-a-barrel scenario would take 16 basis points off global growth, with producers contributing 5 basis points and consuming countries subtracting around 21 basis points. In part, that’s because oil prices at triple digits would get “somewhat less” of a volume response from marginal producers.

The bottom line is that as oil gets closer to $100 a barrel, the net impact of higher oil prices is again becoming a net negative.

“The global sweet spot — where oil prices may have positively contributed to global growth — seems to be somewhere between $50 and $70 a barrel,” they wrote.


9 Comments on "Here’s what happens if the oil rally turns into an ‘oil shock’"

  1. Duncan Idaho on Thu, 24th May 2018 7:01 pm 

    This are really going to tighten up at the end of 2018, and first of 2019.
    We shall see—-

  2. Sissyfuss on Thu, 24th May 2018 11:03 pm 

    In a situation of overshoot the sweetspot is not a constant.

  3. Outcast_Searcher on Fri, 25th May 2018 10:30 am 

    It’s good to see some balance. For the first world, anyway, $100ish oil is an inconvenience, but certainly not a disaster. Mid 2010 to Mid 2014 showed that pretty well.

    What would be more interesting to see would be sustained $150 prices, without a global real estate collapse. But I suspect if the price rise is gradual, that increasing production would make that sustained price unlikely. (Excluding geopolitical spikes).

  4. Davy on Fri, 25th May 2018 11:09 am 

    “Mid 2010 to Mid 2014 showed that pretty well.”

    Aah, OS, how about all that quantitative easing and rapidly dropping rates during that time. Sure it showed well. A Mercedes in every garage would have shown well too.

  5. MASTERMIND on Fri, 25th May 2018 11:59 am 


    Between 2010-2014 the econony grew at its lowest rate since the great depression. despite zero interest rates and a trillion dollar stimulus..Just because the world didn’t come to an end, doesn’t mean everything was fine..

  6. MASTERMIND on Fri, 25th May 2018 12:00 pm 

    Mapping the rising tide of suicide deaths across the United States

  7. MASTERMIND on Fri, 25th May 2018 12:58 pm 

    Noblesville, Indiana, school shooting is at least the 21st of 2018

  8. MASTERMIND on Fri, 25th May 2018 12:58 pm 

    Can you afford to take a summer vacation this year? 24% of Americans say no

  9. MASTERMIND on Fri, 25th May 2018 1:11 pm 

    Just wait till ICE starts snatching US citizens next..And then no one will speak out anymore..We will go full blown China..

    And first they came for…

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