Greece has been the biggest worry of the week. And small wonder. The tale of dodgy debts, widely held, with little understanding of the potential knock-on effects, is too reminiscent of the Lehman Brothers collapse for investors’ liking.
But another concern is bubbling under. It too played a vital – but less widely acknowledged – role in the collapse of 2008. I’m talking about high oil prices.
US consumers have been sheltered partly by their strengthening dollar. But in Britain, we’ve been feeling the pain from rising oil costs for quite some time. The price at the pump has already hit a brand new record for us.
And if crude prices keep rising the way they are now, it won’t just be highly taxed sterling consumers who’ll be wincing when they fill up their cars…
How high oil prices could scupper a recovery
The oil price seems to be unstoppable. Crude rose above $85 a barrel this week. And that’s against a backdrop of a rising dollar.
Hopes that an economic recovery will spur demand seem to be the main thing boosting the oil price. After all, it can’t be lack of supply. Oil cartel Opec “has more than 6m barrels a day of capacity to spare in a pinch,” reports the Financial Times. And in the US, crude oil inventories are comfortably above the average for this time of year, as are gasoline inventories.
The trouble is, all this bullishness on the oil price could be precisely what scuppers any long-term recovery. As Olivier Jakob of Petromatrix tells the newspaper, the “recovery of 2009 was fuelled with crude oil at $62 a barrel, not at $90 a barrel or $100 a barrel. We fear that the latest run… will be the kiss of death for a global economy that was trying to avoid the possibility of a double-dip recession.”
Nervous pundits such as Jakob seem to be in the minority. Plenty of analysts are happy to remain sanguine about the rising oil price. But I fail to see why.
One reason why the global economy was able to rebound so rapidly was because the cost of living fell sharply with the recession. Tanking oil prices meant petrol prices dived too. I remember the surprising sense of relief I felt when the price of a litre of petrol fell back below £1. Well, that hasn’t lasted long.
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And oil is of course, a major input cost. Producer price index data for March showed that input costs rose by 3.6% last month, far higher than expected. If this continues, it won’t just be higher petrol prices we have to worry about – everything else will get more expensive too. That means higher consumer price inflation. And that could mean that interest rates need to rise more rapidly than central banks would like.
Profit from the increasing oil price
That’s the bad news. So how about profiting from the oil price while it’s still heading higher? As always, there’s spread betting if you want to take a punt on oil either rising or falling. You can check out our comparison table here. But do of course bear in mind that this is pure speculation and you can lose a lot more money than you initially stake.
For those who are more interested in a longer-term investment, my colleague Bengt Saelensminde over at The Right Side email likes the look of oil giant BP with its dividend yield of more than 5%.
We’ve certainly been happy to hang on to BP, and for as long as prices keep rising, it looks safe. But as my fellow Money Morning writer David Stevenson has pointed out in the past, BP’s all-important dividend could come under threat if the oil price slides too far.
A more intriguing play on oil could be the search for alternatives. At a recent MoneyWeek roundtable, our experts discussed the outlook for commodities, which included a discussion on the impact of rising demand for ethanol on demand for soft commodities. Subscribers can read the piece here: Eleven commodity assets to buy into now (if you’re not already a subscriber, subscribe to MoneyWeek magazine).
Greece’s problems won’t be ‘contained’
Let’s go back to Greece for a moment. We wrote about the situation yesterday so I don’t want to go over it all again today. But I did just want to mention an interesting piece that Julian Pendock at Senhouse Capital has sent to me.
He compares Greece with the state of Argentina back in 2001, when the South American country defaulted on its debt. The bad news is that Greece looks a lot worse.
Drawing on an analysis from baselinescenario.com, Pendock notes that Argentina’s public debt to GDP ratio was 62%. Greece’s stood at 114% at the end of last year. Argentina’s budget deficit was 6.4% (that still counted as a lot in those days). Greece’s is now close to 13% (not unlike our own).
And he’s not the only one making the comparison. Matthew Russell on M&G’s bondvigilantes.co.uk blog notes the “striking” parallels between the two countries. “Argentina used to operate a currency peg to the US dollar (abandoned in early 2002), effectively the same as having a common currency, in order to keep a lid on inflation.” Both countries used the artificially suppressed interest rates granted by their common currencies to over-borrow.
People also believed that when Argentina eventually defaulted, there wouldn’t be “contagion.” But eventually the Argentine bust led to problems in Brazil and Uruguay, and “resulted in borrowing costs increasing significantly in the region.” As a result, “growth for all countries stagnated”.
And “what is particularly worrying is that, unlike with Greece now, Latin American countries didn’t actually have that much exposure to their neighbour’s debt.” In other words, don’t bet on Greece being ‘contained’.
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