Looming oil price shock that could trigger the next global recession
The Age, 20 November 2017
Revenge, it is said, is a dish best served cold. When Mohammed bin Salman rounded up more than a hundred of Saudi Arabia’s richest businessmen, investors and members of the royal family and imprisoned them in the comparative luxury of Riyadh’s Ritz-Carlton, cheering the crown prince on from the sidelines was one Donald Trump. “Some of those they are harshly treating have been ‘milking’ their country for years!”, he tweeted. Despite the present glut in supply, the oil price has again been creeping up. Long in abeyance, we are seeing the re-emergence of a geopolitical risk premium. Generally, this is taken for granted in the oil price, but in recent years it all but disappeared, apparently made redundant by the advent of US shale. Now it is coming back. Like a siren going off, traders are suddenly waking up to an old bogey – the possibility that rising tensions could close the Strait of Hormuz, through which approximately a fifth of world oil supplies pass.
He didn’t say exactly who he meant, but he must surely have had primarily in mind Prince Alwaleed bin Talal, a Saudi royal who likes to think of himself as the Warren Buffett of Arabia, with a string of apparently successful western investments to his name, including substantial stakes in Citigroup and, until very recently, Rupert Murdoch’s 21st Century Fox.
When Trump essentially went bust in the recession of the early Nineties, Alwaleed helped bail him out by buying his yacht and, just when a crucial debt payment was due to be made, taking a stake in New York’s Plaza Hotel. Strangely, Alwaleed later seemed to take the view that he’d had his pocket felt, and started slagging the then presidential hopeful off on Twitter and on the New York social circuit.
Trump’s eventual victory might have seemed unlikely at the time, but it rarely pays to make an enemy of someone who might actually one day become the world’s most powerful man.
Since his elevation to the presidency, Mr Trump has become cheerleader in chief for bin Salman, with a seeming willingness to back virtually everything he does, including the imprisonment of Alwaleed. For Trump, there’s an element of payback time. The price of freedom is that Alwaleed surrenders more than half of his wealth and agrees for evermore to worship at the feet of bin Salman.
The two things may be disconnected, but Alwaleed now seems to be dumping assets right left and centre. It all sounds like a sub-plot from Game of Thrones, which is sort of what it is. Only with real life implications; these positively medieval goings on have potentially dramatic geopolitical and economic repercussions.
Trump’s unconditional backing for bin Salman has emboldened the new Crown Prince’s regional ambitions. Always fractious relations with Iran grow worse by the day, with a vicious proxy war already being fought in Yemen.
Despite the present glut in supply, the oil price has again been creeping up. Long in abeyance, we are seeing the re-emergence of a geopolitical risk premium. Generally, this is taken for granted in the oil price, but in recent years it all but disappeared, apparently made redundant by the advent of US shale. Now it is coming back. Like a siren going off, traders are suddenly waking up to an old bogey – the possibility that rising tensions could close the Strait of Hormuz, through which approximately a fifth of world oil supplies pass.
Any such disruption, even for a few weeks, would cause the oil price to skyrocket anew, notwithstanding the newly emerged pressure valve of US shale.
It was faintly amusing in this context to see Norway’s sovereign wealth fund last week signal that it would be selling down all its investments in oil and gas, including large stakes in BP and Shell. There is a rich irony, even if the logic is also irrefutable, since Norway’s sovereign wealth fund is entirely founded on the windfall of North Sea oil and gas. For what it is worth, Norway’s central bank, which runs the fund, insists that its strategy is not driven either by environmental concerns or worries that green technologies will end up rendering hydrocarbons obsolete, and therefore reserves stranded. It’s simply that if already deriving much of your income from such reserves, does it really make any sense to double up and invest the proceeds in even more? Even so, the move seems to mark another milestone on the road to Big Oil’s eventual demise.
That said, the journey’s end is still plainly a long way off. Despite the now almost exponential growth in renewable energy, oil still has the power to shock. Closure of the Gulf strait would cause the price to at least double, delivering a heavy blow to the world economy similar to a substantial rise in interest rates.
A rising oil price is both inflationary and deflationary at the same time; it adds to prices, but by doing so, it takes money out of other forms of consumption and thereby depresses overall demand. If there is one thing pretty much guaranteed to bring the economic expansion of recent years to an end and tip the world back into recession, it would be an oil price shock. Don’t believe that renewables in combination with American shale have entirely insulated us against this hardy perennial of a threat to global growth. They haven’t.