Oil and trouble

If $120-a-barrel Brent crude is a threat to the global economy, someone had better tell the stock market. The MSCI World Index has largely kept pace with the rising price of oil this year. For now, stronger-than-expected economic growth appears to be overshadowing equity investors’ concerns about tight supplies of oil. Worries about Iran may keep trading volatile. But, absent a serious flare-up in the Persian Gulf, any spike in crude prices should be mostly self-correcting.1

It would be a mistake to dismiss the supply risks. But, Iran’s decision to pre-empt the EU’s oil embargo by halting crude shipments to the UK and France is unlikely to have much of a permanent price impact. Neither country is reliant on Iranian crude and European buyers have had plenty of time to line up alternative supplies since the embargo was set in January.

Other supply disruptions may emerge and surprise. Consider the recent suspension of exports of 350,000 barrels per day from South Sudan, for example. But, it will take something much bigger to create a real problem. South Sudan’s production outage was equivalent to less than one-half of a per cent of global oil demand, or about a seventh of Iran’s 2.5 million barrels per day of oil exports. Analysts at Deutsche Bank calculate that the world’s major supply disruptions, excluding the EU’s Iran embargo, could total about 1.2 million barrels a day. Assuming that at least some of Iran’s exports keep flowing, spare the OPEC capacity, which IEA estimates put at 2.8 million barrels a day in February, should cover supply shortfalls.

Sure, the oil market is unusually tight, but supply-side risks are well known and should already be priced in. That leaves demand, as the more likely culprit behind crude’s recent run-up. Economic data in the United States is impressing and Asian demand has held up. Money remains incredibly loose too, with China, Europe and Japan all having taken fresh measures to boost liquidity in recent weeks.

In an environment with relatively few attractive investments, these factors may put a floor under commodity prices. But, a demand-driven price spike should, for the most part, burn itself out before it threatens world economic growth.