By John Kemp
LONDON Feb 22 Political leaders in the
United States and Europe could soon face an uncomfortable choice
between raising the pressure on Iran further or taking steps to
safeguard their economies from the damage wrought by rising oil
Confrontation with Iran and a series of supply disruptions
in South Sudan, Syria and Yemen have pushed prices back to
levels that derailed the recovery in the United States and
Europe last year, and could do again in the first half of 2012.
If prices continue rising, releasing oil from
government-controlled stockpiles will look attractive to
policymakers keen to maintain the embargo but anxious to avoid a
stalling economy in a U.S. election year.
Experience suggests the full extent of the damage will not
be apparent until the second or third quarter, because oil
prices filter through to measurable changes in consumer spending
and business investment with a lag of several months.
The best way to understand how oil prices are likely to
affect the economy is to examine how the recovery was influenced
by the last big rise and fall in prices between August 2010 and
April 2011 ().
Between August 2010 and January 2011, front-month Brent
prices rose $20 per barrel (25 percent) following Fed
Chairman Ben Bernanke's Jackson Hole speech foreshadowing a
second round of quantitative easing, and then another $26 (27
percent) between February and April following the outbreak of
the Libyan civil war and the earthquake at Fukushima.
Throughout the period the economy appeared impervious. Many
oil analysts dismissed reports of demand destruction as
"premature" and predicted prices would need to rise much further
to bring demand back into line with restricted supply
Equity prices rose strongly. The Standard and Poor's 500
index rallied over 20 percent between August 2010 and
The U.S. economy continued to report big gains in
manufacturing output and employment. The Institute of Supply
Management's (ISM) composite manufacturing index averaged 58.5,
well above the 50-point threshold dividing expanding activity
from a contraction. Private sector employers averaged payroll
gains of 185,000 positions per month.
Then it all went wrong. May proved to be the cruellest
month. Oil prices plunged, but too late to save the recovery
Private sector job gains slumped from 264,000 in April to
108,000 in May and 102,000 in June. The ISM composite collapsed
more than 5 points, and another 4 points by July.
The economy stalled, prompting the Federal Reserve to
promise further stimulus at its August meeting in the form of a
soft commitment not to raise interest rates until at least the
middle of 2013.
Many macroeconomists and oil analysts dismiss comparisons
with the rise in oil prices in 2011, arguing the recovery is now
much more well-entrenched. In particular, they point to growth
in manufacturing and employment as a sign the economy is on the
mend and should be able to weather price increases.
But evidence for this view is scant. Private job gains in
December (220,000) and January (257,000) are almost exactly in
line with job creation in February (257,000) and March (261,000)
last year. The ISM's composite index (54.1) is actually below
year-ago levels (59.9).
The current level of the S&P 500 (1362) is not much
different . The Fed is providing strong support for the
recovery with its prediction interest rates will need to remain
low until at least late 2014, but last year it was also
providing strong support by completing its $600 billion
Historical parallels are never exact. But there are enough
similarities that it would be foolish to dismiss the threat of a
similar slowdown in the economy in the months ahead, most likely
to be felt between March and June.
There are already signs the recovery is faltering: an
unexpected dip in U.S. consumer confidence this month; business
surveys pointing to a continued contraction in manufacturing
activity across the euro zone; and the fourth consecutive
monthly contraction in China's manufacturing sector in the face
of slowing export orders .
Political leaders across North America and Europe are caught
in a dilemma. On the one hand, most are convinced of the need to
maintain sanctions on Iran's exports and continue pressuring the
government in Tehran to curtail its uranium enrichment
programme. Facing a tough re-election fight later this year,
U.S. President Barack Obama cannot afford to show any sign of
weakness in foreign policy, especially towards Iran.
On the other hand, the president's re-election hopes could
be sunk if rising oil prices push the economy into recession.
European governments could also be vulnerable if voters blame
rising oil prices on sanctions and conclude the embargo was an
Political pressure to cap or reverse the rise in oil prices
is already high. It will become intense if prices break through
last year's highs around $125 (Brent) and $110 (WTI) and
the rise is blamed on the sanctions process.
CURBING PRICE RISES
Assuming that tensions with Iran cannot be defused, and
policymakers opt to maintain sanctions, there are a number of
options for trying to blunt the economic impact.
The simplest would be to encourage more Iranian exports to
China, India and other markets across Asia. The original
sanctions "game plan" called for rising exports of (discounted)
Iranian crude to China and other developing markets to offset
the loss of market access in Europe, Japan and Korea and keep
global oil supplies steady.
The plan has gone wrong because Iran has so far refused to
offer large enough discounts and many Asian buyers are wary of
taking Iranian oil and relying on uncertain U.S. forbearance
from enforcing penalties. U.S. officials could, however,
re-emphasise that a certain level of "permitted non-compliance"
is assumed and even encouraged.
Such messaging is difficult to get right. But arguably U.S.
and European officials could do more to reassure Asian crude
buyers that they will not be punished for buying Iranian crude.
The second option is to try to resolve some of the other
disruptions currently affecting oil supplies. Western
governments may not be able to do much about the loss of crude
from Syria, but officials could step up pressure on Sudan and
South Sudan to settle their dispute over transit fees.
IEA STOCK RELEASE?
The third option is to order another release from government
stockpiles. So far, officials have implied stocks would only be
released in the event of a disruption to oil flows through the
Strait of Hormuz. In reality, the conditions for release are
likely to be interpreted more flexibly.
A pre-emptive release of supplies to forestall a dangerous
rise in prices is probable if officials assess there is a threat
of Brent prices breaking through the $125-130 level.
Purists will complain the International Energy Agency (IEA)
should not release stocks unless there is a loss of Iranian
and/or Saudi exports, but the bar to releasing stocks is much
Declining commercial inventories and the loss of physical
supplies from South Sudan, Yemen, Syria and as a result of
complications around Iran's exports, coupled with the need to
avert the economic fallout from a further rise in prices, would
provide the immediate justification.
In its statement justifying last year's release, the IEA
cited "the ongoing disruption of oil supplies from Libya. This
supply disruption has been underway for some time and its effect
has become more pronounced as it has continued ... Greater
tightness in the oil market threatens to undermine the fragile
global economic recovery."
Rightly or wrongly, the same logic could be applied to the
loss of exports from Iran and South Sudan.
Stock releases are above all a political decision. If prices
continue rising, the pressure to counter them by releasing
stocks may become irresistible.