An Energy Shock: Why Is It A Risk For The Economy And How Could One Occur?

Some headlines from around 2PM Thursday of last week:




Translation: The ongoing war between Israel and Iranian proxies just took another step towards just being an outright conflict between Israel and Iran proper.

Here is an article on the tough talk and what it means. Here is another.

Israel v Iran is the nightmare of all nightmare scenarios in the Middle East.

Oil predictably jumped 2% on the above news. The S&P 500 also reversed its solid gains and ended the day down 1.23% on the day. This meant that suddenly and also quietly, oil closed over $90 a barrel.

That move only added to already impressive and impressively under-discussed rally. Crude has recorded a positive performance every month of 2024 so far. US West Texas benchmark is up over 23% while European Brent crude is nearly 20%.

And we have not yet reached the "summer driving season" where higher Western demand meets tougher refining conditions in the northern hemisphere.

There are two conclusions from this:

  • This hasn't yet been a story but it is about to be.

  • If you are wondering what could stop the economy (and the stock market), dramatically higher energy prices would do it.

On the first point: the White House and half the country may be dead set against this narrative taking hold but enough Americans still drive that they are going to notice and that attention will swiftly bring even reluctant media organizations around.

One of the interesting wrinkles about the cost of energy is that prices are broadcast on streets all over the country by gasoline stations. Located along highways and major streets and intersections in big cities and small towns, red states and blue cities, rich neighborhoods and the inner city, these signs act as a barometer for consumer sentiment and outlook.

It is very, very difficult for Americans to feel positive about the economy if energy prices are high. It is also an incredibly difficult fact to obfuscate.

There is no hiding from high energy prices.

Nonetheless, we here at Pebble HQ look forward to the mainstream media sitting down to pen "Here is why higher gasoline prices are good for the economy (and you!)" type articles. It is going to be fun.

Higher oil is (also quietly) having concrete policy actions as well:

  1. With prices at these elevated levels, the Biden administration has stopped refilling the Strategic Petroleum Reserve.

  2. It has decided not to e-impose the well deserved sanctions on Venezuela.

On the SPR front: buying back oil was proving both ruinously expensive for the already stretched budget and the demand from government buyers was also just tightening an already tight market. Greater government demand on top of greater private demand quickly flows through to higher prices.

We keep meaning to find the space to write about the disastrous easing of sanctions on Venezuela. To bring a long story short, we have made a series of very foolish mistakes. These include removing the sanctions unilaterally in return for some airy promises about this summer's elections that, of course, have never materialized.

This is a particularly puzzling move because we are transferring capital and offering to buy oil from a regime deeply inimical to our interests and terrible to its own people at a time when we are trying to limit our own energy industry.

Even more incredibly is the fact that the kleptocratic, autocratic and brutal regime is now threatening not to take its own citizens back if the US imposes sanctions.

Here ia Delcy Rodiguez, Vice-President for Life in El Pais: “If they make the mistake of intensifying the economic aggression against Venezuela . . . repatriation flights for Venezuelan migrants will be immediately revoked as of Feb. 13.”

Incredibly we are now fully boxed ourselves into a corner where we somehow have no leverage and no chance of democracy in Venezuela. Quite a feat!

On the second point, it is important to note that we don't actually need a full Middle Eastern war between Israel and Iran to cause materially higher energy prices.

Rather a combination of continued low scale supply disruption (Houthis in the Red Sea, Ukrainian attacks on Russian energy infrastructure) and steadily increasing demand (US and other still robust economies) could be enough to slowly get energy prices to near the psychologically and economically important $100 level.

But right now there is a slow but steady accumulation of both headlines (see above) and also structural trends out of the region that are causing real concern to oil traders and global energy markets.

It will likely only be a matter of time however. And that brings us to our next point:

What to do about all this? On that front, we actually have some good news but you will have to wait for next week.


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