“Oil Shock!”

Is the economy in for a jolting “oil shock”?

Today we wander out to the tail end of the bell curve… look around for black swans… and raise scandalous questions.

“Judging by internet searches for the term,” says Bloomberg commodities analyst David Fickling, “an oil shock is the last thing anyone should be worried about.”

It is true — “oil shock” is an orphan term, unloved, unwanted — and unsearched:

Chart 1

We would be “shocked” if the search term “oil shock” drew any attention at all these past few years.

After nicking $115 in June 2014, oil slid all the way down the greasy pole to $26 in February 2016.

It has been rebuilding steam for the past two years — but quietly.

Oil has since taken a long, meandering route to last month’s $72… before retracing a few steps.

Today a barrel of West Texas Intermediate Crude fetches $66.

That nonetheless represents a 170% increase over the past two years.

And UBS economists claim the 46% spike over the past year alone is the 11th largest of the past 70 years.

Pretty handsome, you say.

But hardly suggesting oil “shock.”

This is not the oil shock of the 1970s when OPEC put the squeeze on us.

But must it be that extreme to disrupt?

Economist James Hamilton of UC San Diego has drilled into the history of oil shocks.

To truly shock, he finds, oil prices need not rise dramatically.

Oil prices need only rise above their peak for the previous three years.

That is, they needn’t return to 2014’s $115 to constitute a shock… or even $100.

The threshold is much lower.

Recall, today’s price is $66.

Before last November, oil had not cracked the $60 mark since June 2015 — precisely three years ago.

Today’s $65–72 range thus exceeds the peak price over the past three years.

By this narrow definition… we are witnessing an oil shock.

To illustrate, take some liberty and extend the analysis a year or two…

Bloomberg columnist David Fickling notes that oil prices averaged roughly $30 in the mid-1980s before falling to an average $20 until decade’s end.

Then Saddam Hussein moved on Kuwait in 1990.

In the five months leading up to Operation Desert Storm, oil prices spiked to an average $30.84.

Prices had only reverted to their mid-’80s average, in other words.

But that spike, Fickling concludes, was sufficient to trigger the recession of the early ’90s — at least in part.

Do not focus on the dollar price we are asked to conclude… but the current price compared with recent peaks.

And by that measure, Hamilton argues we are presently witnessing the largest oil shock since 2008 — when prices shot to an obscene $144:

Chart 2

Incidentally… many analysts project the highest gas prices in four years this summer.

Maybe this is some sort of quiet oil shock, you agree grudgingly.

But the big deal is what precisely?

The economy is in swell shape, you say.

Unemployment is at multidecade lows… tax cuts are fattening the national purse… markets are regaining their bounce after February’s correction.

And mainstream consensus dismisses the possibility of an oil shock.

Bank of America Merrill Lynch is typical when it says it doesn’t expect higher oil to produce “a material slowdown in growth.”

But we would remind you that mainstream forecasters are perpetually in the mists.

IMF economist Prakash Loungani revealed the results of a recent study…

These results demonstrated that the professional wiseacres missed 148 out of 153 world recessions — a nearly imperfect record.

Why should now be any different?

And let the record show…

Substantial oil increases have preceded 10 of the previous 11 business cycle peaks since World War II.

Moreover, they approach on cat’s paws… and pounce without warning.

The aforesaid David Fickling:

Oil shocks are prophets — not partners — of economic downturns. This means that one shouldn’t expect to see other signs of weakness until the shock has already taken root.

So unless supplies surge and prices ease sharply, and in the very near future to offset what has already been a remarkable “oil shock,” the next downturn may already be a foregone conclusion.

Is the next downturn a foregone conclusion?

We do not pretend to know.

But few are taking any note of an oil shock right now — which we find worrying.

The bullet that gets you is often not the one you hear… but the one you don’t…


Brian Maher
Managing editor, The Daily Reckoning

The Daily Reckoning