Liam Dann: On a knife-edge – How an oil shock could shake the world

OPINION:

The big flaw with conspiracy theories – if we take the lack of scientific rigour for granted – is the tragic inability of humans to agree on anything for any length of time.

While it might be technically possible to fake a moon landing, the prospect of all those involved keeping quiet about it for more than 50 years is entirely unbelievable.

Humans are not very good at conspiring.

Take oil as a timely example.

It’s one of the most plausible areas for potential conspiracy.

There literally is a tiny group of men who control most of the world’s supply – it’s called Opec.

And yes they do try to influence the price of the stuff.

They were supposed to be doing it last week.

But they had an argument and their big meeting got cancelled.

So Brent Crude prices have fallen about 5 per cent since Monday.

As Reuters reported on Friday morning: “Talks between the Organisation of the Petroleum Exporting Countries and its allies, including Russia, known as Opec+, fell apart when de facto leader Saudi Arabia refused demands from the United Arab Emirates to raise its output under the group’s supply cut agreement.”

Things move fast on global markets. This column was originally supposed to be about the threat of rising oil prices pushing inflation into uncontrolled territory.

Oil prices more than doubled between November and last Monday’s close.

The threat of further spikes is a serious inflationary concern.

That fits nicely with the rising interest rate story that’s dominating business news.

In the conspiracist version of this story there would be some nefarious geo-political reasons for attempting to constrict supply and pushing the oil prices up.

The fact the Russians are there and trying to mediate the dispute doesn’t hurt the narrative.

An unanticipated oil shock right now could tip inflation over the edge and derail the US economy.

There’s been a lot of worrying lately that the global economy is harking back to the wild inflationary days of 1970s.

Could history be repeating?

Sadly, for those who enjoy a good conspiracy theory, the reason for the big stand-off between the Saudis and the UAE is more boring.

It’s just a dispute over who gets what share when output is adjusted.

The Saudis want a collective agreement to lifts output at a moderate pace.

The UAE isn’t happy with the last deal done in 2018 and sees a chance to renegotiate.

It wants to individually produce more oil.

Unlike the 1970s, this isn’t an attempt to engineer an inflationary price spike.

Opec understands very well that a serious spike in the price would be counter productive – on two fronts.

From a long-term point of view, higher prices just incentivise the acceleration of alternative energy use.

From a more immediate point of view, when prices rise too far they incentivise US shale oil producers to fire up their pumps or dredges or whatever they use for that dirty environmentally, nasty stuff.

That’s what happened in 2014, causing an epic oil price crash and derailing efforts to get interest rates back to pre GFC levels.

The slump sucked emerging inflation out of the world economy and forced central banks onto the back foot – where they were more or less still stuck when Covid hit.

In New Zealand, the Reserve Bank had to reverse course after three rate hikes.

So Opec is looking for a sustainable sweet spot on pricing.

We should hope they find it.

An orderly return to fair value for oil prices over the next year would make the global recovery a lot less volatile.

At around US$75 a barrel, the oil price is still relatively low.

But it’s the pace of change that will cause problems.

An oil shock right now – in either price direction – could be disastorous.

What happens to the price of oil has enormous bearing on our everyday lives, and not just in terms of the price of filling up the petrol tank. Shipping and airfreight, manufacturing of plastics … there’s almost nothing we buy that is untouched by the price of oil.

So it has a unique capacity to shift the dial on inflation, which in turn flows through to decisions about our interest rates and other vitally important markets like housing.

And inflation is on a knife edge.

In New Zealand it appears to be on the rise. Last week, all four major banks shifted their forecasts for a hike in the official cash rate to November.

The economy has been running so hot that rate hikes arestarting to look like a certainty this year.

But we should assume nothing. In Covid-world, November is a long way off.

Even the Reserve Bank’s next rate review on Wednesday is a long way away.

Oil’s just one of the variables that could ruin the recovery party.

Equity markets are another. At some point, or possibly several points, over the next year, sharemarket investors are going to freak out about the prospect of rate rises.

If that freak-out manifests in a big enough market crash then they may get what they wish for: another cycle of low rates.

And of course we simply can’t be certain about rate hikes and economic recovery while Covid is still so rampant in the world.

Like Wall Street sentiment or an Opec stand-off, the pandemic situation can change overnight leaving us staring at economic forecasts that no longer make any sense.

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