With popular and sometimes violent uprisings daisy-chaining their way from Tunisia to Egypt to Libya and beyond, protesters in the so-called MENA region (Middle East and North Africa) have given fresh meaning to the old “domino theory” of political revolution.
Economists are now fretting over daily swings in the price of oil, which recently surged to more than US$105 per barrel — its highest level in more than two-and-a-half years. The MENA region supplies about a third of the world’s oil, and the question now is how much further prices could rise as the region descends deeper into turmoil. Thanks to rolling unrest over government corruption, unemployment and food prices, the stability of authoritarian regimes (not to mention a few democratic ones) is being tested around the world, but especially in the world’s oil-soaked heartland. Despite all the stimulus spending doled out over the past two years, the threat of another recession is looming large as ever. The global economy has recovered strongly in recent months, but rising oil prices not only put the squeeze on fragile consumers, they also raise the spectre of inflation and fan the flames of political unrest.
According to David Kotok, head of Florida-based Cumberland Advisors, we are watching “a sea change” occur among 10% of the world’s population. And since scenarios with benign outcomes and peaceful transitions appear relatively remote, he argues the risk of recession returning to North America and Europe is rising daily. “Modern technology,” Kotok insists, “allows turmoil to be exported quickly from place to place.”
When asked how hard civil uprisings could hit the global economy, the influential U.S. fund manager wasn’t prepared to rule out protester-induced economic slowdowns in China, where government anxiety has central Beijing flooded with police and attack dogs, and Russia, where hundreds of demonstrators recently gathered in central Moscow, amid freezing temperatures, to rant against corruption and rising prices.
Regional uprisings started in Tunisia, where an unemployed college graduate set himself ablaze earlier this year after police confiscated his only source of income, a fruit cart. That incident sparked protests, which quickly spread to nearby countries. Oil prices took off when the crisis hit Egypt, threatening to choke off oil supply lines by closing the Suez Canal.
Markets are now focused on the raging battle for Libya, which produces more than 1.6 million barrels per day. According to the International Energy Agency (IEA), daily output there has already dropped by more than 50%, primarily because foreign oil workers are fleeing for their lives. In early March, as rebels fought for control of the country’s east coast ports, where much of the country’s oil is refined or shipped abroad, the price of the American crude contract (West Texas Intermediate, or WTI) broke US$100 for the first time since 2008.
At press time, WTI crude prices had already surpassed US$106 in intraday trading. That had White House policy-makers worried enough to contemplate releasing some of the nation’s strategic oil reserves. And there is no question that oil prices could go much higher.
From an oil supply perspective, the immediate concern is Saudi Arabia. The kingdom’s leaders have vowed to crack down on protests, which are banned. But the government is clearly concerned about losing control. In early March, Saudi authorities freed Sheikh Tawfiq al-Amer, a Shia cleric arrested last month after calling for a constitutional monarchy.
Everyone concerned about oil prices should watch Bahrain, according to global intelligence company Stratfor. Libya’s protests are more violent, it notes, but unrest in Bahrain could push the Shiite minority in Saudi Arabia to rise up. That could cut off a major supply of oil while potentially handing the region’s balance of power to Iran, which could end up in control of the routes used by 40% of the world’s seaborne oil.
The general consensus among economists is that crude oil prices need to climb dramatically higher before threatening the global recovery. And plenty of market watchers think supply disruptions will be contained because Saudi Arabia, the world’s top oil producer, is moving to cover Libya’s lost barrels. Then again, many analysts fear the worst is yet to come. After all, the outcome of uprisings in MENA could disrupt the global economy more than the conflicts themselves, especially if the victors move to punish foreign companies with close relationships to the local dictators under attack.
Italian energy major ENI, for example, stands to lose a lot. As Stratfor notes, thanks to ENI, Italy is the largest consumer of oil from Libya. Since the 1950s, the company has relied on operations in Libya, where it secures 15% of its global output. But it has never once retreated, nor stopped supporting Moammar Gadhafi, not even when Pam Am Flight 103 was downed by Libyan agents and UN sanctions were levied against the North African state. As a result, says Stratfor, there is “much risk and little opportunity ahead in ENI’s future relations with Libya.”
Furthermore, while the media focus on Egypt has ended, the nation’s state of emergency has not. The economic impact of Egypt’s revolution will be long-lasting and possibly far-reaching. As Stratfor points out, the country has one of the most static economies on the planet. The US$13-billion tourism industry is the nation’s most important income stream, and it has just been completely gutted during high season. Military rule will certainly not improve the nation’s 8%-of-GDP budget hole or its 72%-of-GDP debt load, which is already well beyond the point that pushed Argentina to default on its international debt obligations back in 2001.
The reaction of foreign exchange markets to MENA turmoil threatens to further push up oil prices. As pointed out by Justin Bennett, a technical analyst with the Dynamic Wealth Report, an investment e-letter, the U.S. dollar hasn’t been soaring as market fear spreads. As a result, there is now concern that the greenback is losing its traditional cachet as a safe haven for investors. If true, expect more fuel to be added to the commodities fire, further increasing drag on global economic activity while adding to the already worrisome upward pressure on inflation. “Oil, gold and silver will all likely see more strength due to their inverse relationship with the dollar,” Bennett says.
Wall Street economist Robert Brusca says Bennett has made an interesting observation. But he notes the euro may be attracting attention away from the dollar because of speculation over rate hikes out of the European Central Bank. He also notes safe-haven traffic could have been significantly disrupted by Saudis willingness to make up for lost oil production. “If this thing spreads further, then we’ll see if there is any dollar impact or not,” Brusca says.
Oil supply concerns are greater for Europe, where crude prices have jumped even higher due to the region’s larger energy reliance on MENA. Thanks to mounting inflation concerns, the EBC is now widely expected to raise interest rates before the EU economy is on a stable footing and ongoing sovereign debt issues are resolved.
Berkeley economist Barry Eichengreen recently told Spiegel Online that Europe will find no way around rescheduling Greek debt, which will hurt the balance sheet of banks that own Greek bonds. And when the time comes to crisis-proof balance sheets in the eurozone, he puts the cost of recapitalizing German and French banks alone at 3% of Franco-German GDP, or about $245 billion.
Alex Jurshevski, CEO of Toronto’s Recovery Partners, notes Europe is still “at risk of implosion.” At minimum, he says, “we’re looking at elevated rates of inflation.” This will pressure term rates, hit government budgets and could prove to be the last straw that forces the weak EU camels to default on debt. “One thing is certain,” he says. “None of what is going on in MENA is good news, in the short and medium term, for anyone.”
Our own national economy grew at an annualized rate of 3.3% in the fourth quarter of 2010, a full percentage point above what the Bank of Canada expected. Nevertheless, when making interest rate policy in early March, BoC governor Mark Carney overlooked rising pressures on inflation and left the central bank’s target for Canada’s overnight rate at 1%. Carney’s decision to maintain loose monetary policy in this country stems from external risks to the economy. “Ongoing challenges associated with sovereign and bank balance sheets will limit the pace of the European recovery, and are a significant source of uncertainty to the global outlook,” the bank noted.
Oil prices were not directly mentioned. But they have clearly increased the external risks to our economy, especially to the battered auto sector, which is dependent on U.S. consumer spending. The world’s largest economy made an important leap toward sustainable recovery in January, when the jobless rate dropped below 9%. But every dollar increase in the price of oil leads to a 2.5? per gallon increase in U.S. gas prices. And every extra penny in gas prices taxes U.S. consumers at the rate of US$1.2 billion per year.
Kotok has seen crude price estimates over the next five years that range from US$220 to US$30. He isn’t convinced either extreme is likely. But he certainly isn’t ready to bet on the optimist camp that thinks Venezuela president Hugo Chavez can play the role of peace broker.
“One needs to put this MENA contagion into the millennium-old perspective of the Shia-Sunni schism in Islam,” he noted in a recent market commentary. “Think about it as you think about Catholics vs. Protestants or the War of the Roses. Put that type of historical enmity into an Islamic setting. No way is this over.”
Cumberland — which manages about US$1.5 billion — was quick to redeploy cash as soon as global equity markets showed signs of strength in the post-meltdown period. But it started exiting equity markets in January. By early February, the firm was sitting on its highest cash reserve since the Lehman-induced run on markets in 2008. Today, energy markets and cash pretty much sums up Cumberland’s strategy.
The civil unrest that started with a match in Tunisia may quickly burn out, leaving governments in Saudi Arabia, China and Russia standing strong. Oil markets could quickly settle down before pushing Europe over the brink and denting the renewed American love affair with Detroit’s SUVs. Or everything could hit the fan at once.
It is perhaps a good time to remember the confident chorus that insisted America’s mortgage crisis would be contained just before it almost brought down the global financial system. Indeed, as analysts at TD Economics freely admit, political scientists are now the people to ask about recession risks.