Friday, April 18, 2014
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Scary Oil

NEW YORK – Today’s fragile global economy faces many risks: the risk of another flare-up of the eurozone crisis; the risk of a worse-than-expected slowdown in China; and the risk that economic recovery in the United States will fizzle (yet again). But no risk is more serious than that posed by a further spike in oil prices.

The price of a barrel of Brent crude, which was well below $100 in 2011, recently peaked at $125. Gasoline prices in the US are approaching $4 a gallon, a damaging threshold for consumer confidence, and will increase further during the high-demand summer season.

The reason is fear. Not only are oil supplies plentiful, but demand in the US and Europe has been lower, owing to decreasing car use in the last few years and weak or negative GDP growth in the US and the eurozone. Simply put, increasing worry about a military conflict between Israel and Iran has created a “fear premium.”

The last three global recessions (prior to 2008) were each caused by a geopolitical shock in the Middle East that led to a sharp spike in oil prices. The 1973 Yom Kippur War between Israel and the Arab states led to global stagflation (recession and inflation) in 1974-1975. The Iranian revolution in 1979 led to global stagflation in 1980-1982. And Iraq’s invasion of Kuwait in the summer of 1990 led to the global recession of 1990-1991.

Even the recent global recession, though triggered by a financial crisis, was exacerbated by spiking oil prices in 2008. With the barrel price reaching $145 in July of that year, oil-importing advanced economies and emerging markets alike faced a recessionary tipping point.

The risk that Israel’s threat to attack Iran’s nuclear installations will, in fact, lead to an outright military conflict may still be low, but it is growing. Israeli Prime Minister Binyamin Netanyahu’s recent visit to the US demonstrated that Israel’s fuse is much shorter than the Americans’. The current war of words is escalating, as is the covert war that Israel and the US are allegedly engaging in with Iran (including killings of nuclear scientists and use of cyber-warfare to damage nuclear facilities).

Iran, with its back to the wall as sanctions bite harder (especially the recent SWIFT and central bank restrictions, and Europe’s decision to stop importing Iranian oil), could react by increasing tensions in the Gulf. Eventually, it could easily sink a few ships to block the Strait of Hormuz, or unleash its proxies in the region, which include pro-Iranian Shia forces in Iraq, Bahrain, Kuwait, and Saudi Arabia, Hezbollah in Lebanon, and Hamas and Islamic Jihad in Gaza.

Recent attacks on Israeli embassies around the world appear to signal Iran’s reaction to the covert war being waged against it, and to the tightened sanctions, which are aggravating the effects of the regime’s economic mismanagement. Likewise, the recent escalation in cross-border fighting between Israel and Gaza-based Palestinian militants could be a sign of things to come.

The next few weeks could bring a reduction in tensions, as the US, France, Germany, the United Kingdom, China, and Russia go through another round of attempts to prevent Iran from developing nuclear weapons or the capacity to produce them. But if this attempt fails, as is likely, one cannot rule out that, by summer, Israel and the US agree that, sooner rather than later, force will have be used to stop Iran.

Indeed, while Israel and the US still disagree on some points – Israel wants to strike this year, while the Obama administration is opposed to military action before facing the voters in November – the two sides are converging on aims and plans. Most importantly, the US is now clearly rejecting containment (accepting a nuclear Iran and using a deterrence strategy). So, if sanctions and negotiations don’t credibly work, the US (a country that doesn’t “bluff,” according to Obama) will have to act militarily against Iran. The US is now providing bunker-buster bombs and refueling planes to Israel, while the two militaries are increasing joint military exercises in case an attack becomes necessary and unavoidable.

If the drums of war grow louder this summer, oil prices could rise in a way that will most likely cause a US and global growth slowdown, and even an outright recession if a military conflict erupts and sends oil prices soaring.

Moreover, broader geopolitical tensions in the Middle East are not fading, and might intensify. Aside from deep uncertainty regarding the course of events in Egypt and Libya, now Syria is on the verge of civil war, and radical forces may get the upper hand in Yemen, undermining security in Saudi Arabia. There is still concern about political tensions rising in Bahrain and Saudi Arabia’s oil-rich Eastern Province, and potentially even in Kuwait and Jordan, all areas with substantial Shia populations or other restless groups.

Now that the US has left Iraq, rising tensions between Shia, Sunni, and Kurdish factions do not bode well for the country’s ability to boost oil production soon. There is also the ongoing Israel-Palestine conflict, tension between Israel and Turkey, and hot spots – particularly Afghanistan and Pakistan – in the wider neighborhood.

Oil is already well above $100/barrel, despite weak economic growth in advanced countries and many emerging markets. The fear premium might push prices significantly higher, even if no military conflict ultimately takes place, and could trigger a global recession if one does.

Read more from our "The Roubini Factor" Focal Point.

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  1. CommentedY. K.

    There's another risk in the ME which is for some reason glossed over: The Arab Spring's effect on Saudi Arabia and other oil-producing countries. In other to keep the populace from revolting, the saudis had to expand brib^W social and other programs. Some estimates (e.g. "Why the Saudis want $100-a-barrel oil" at Washington Post) argue that the saudis need $100/bbl to afford it. This situation isn't much better at other autocratic oil-producing countries - Russia needs $110/bbl to keep it's programs.

    Since none of these leaders wants to end up like Gaddafi or Mubarak, there's no way to pressure them to lower prices. So we're stuck with >$100 for a good while.

  2. CommentedPaul A. Myers

    The basic premise that Israel's threat to attack Iran is growing and will continue to do so as the year progresses is probably wrong; the risk is receding and will probably be slight after the November election. The Obama administration is not going to engage in armed hostilities with Iran no matter how much it is egged on my its client state Israel. At the end of the day, Israel is still a client.

    The assertion that US and Israel aims and plans are "converging" seems fanciful.

    The assertion that the US is rejecting containment and the idea of accepting a nuclear Iran which could be contained by deterrence also seems fanciful. Deterrence works.

    The assertion that Obama's political statement "doesn't bluff" guarantees inevitable military action indicates an inability to grasp the art of posturing in these types of situations.

    The idea that the US military is conducting joint exercises with Israeli military forces so they can conduct a joint campaign against Iran seems like some sort of Likud party fantasy. A joint campaign against Iran may or may not stop the Iranian nuclear program; it would probably bring down the government in Washington, some of whose denizens may grasp that point.

    Overt military action would bring on a recession, or possibly something much worse. Therefore overt military action involving the US military is probably remote. Why have a recession when the simpler, cheaper alternative of deterrence has a proven record of working.

    Yes, tensions are rising across the Middle East. Most likely, countries outside of the region will stand by and watch as they boil over here and there, possibly with horrific consequences for the people involved. Nevertheless, the outside nations will most likely stand by and ultimately watch. Libya was an exception, not the new model.

  3. CommentedZsolt Hermann

    It might be difficult to see at first but the whole tension, and all the problems could be inflated by a single decision: abandoning our present, artificial and totally unnatural constant growth, expansive, exploitative economic model and the geopolitical structure maintaining and serving it.
    Moreover we do not even have much choice in the matter as this model is self destructing as we speak, either by to collapse of the artificially inflated financial markets, or growing public awakening leading to violent demonstrations, even civil wars, or exhausting natural resources, or increasing pollution leading to catastrophic climate change, or regional or even world wars to capture the remaining markets and energy resources, either way we are in an end game.
    The usual evolution method of waiting until the situation becomes unbearable and then change would be very unpredictable and disastrous.
    The wise move would be to take stock, humbly accept defeat with our present civilization model, and start building a new mutually considerate structure based on our historical experience and the scientific, factual knowledge about our new, global and integral world, helping people understand world wide that we are totally interconnected and each of us depend on everybody else.
    As the article suggests, we are running out of time to make the wise decision.

  4. CommentedLuke Ho-Hyung Lee

    Absolutely, I agree with you Prof. Roubini, but I would also suggest you consider another fundamental cause of the current global recession.

    Believe it or not, we have made a serious mistake in real markets and have developed no integral public supply chain infrastructure at all over the last 20 to 30 years of the Modern Information Age. I believe this lack is the real cause of the current worldwide economic crisis.

    Please see: “To have Prosperity or to have Decline, it depends on Your Choice” http://goo.gl/AeP9O

    Without first developing the appropriate public infrastructure by fixing that mistake in the modern supply chain information market, every new effort will be just as ineffective and useless as everything else we have tried. That is, there will be no sustainable solutions for the current economic and social crisis, whatever we do. I believe our leaders and people should recognize this as soon as possible.

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