The following chart illustrates the global economic slump in 2008. The Baltic Dry index is the benchmark index for global freight rates of bulk goods (among others iron ore, copper, gravel, grain, and coal) and is thus an important indicator for global trade. As such, it also constitutes a reliable leading indicator for the oil price. The chart shows that the Baltic Dry index is currently developing a massive divergence from the oil price, which has been gradually getting wider.
Baltic Dry index vs. oil price
Source: Datastream, Erste Group Research
Taking into consideration all Baltic indices, one may start to doubt the global economic recovery. But to be fair, one has to note that the capacities of the big shipping companies have increased drastically. However, prices should still rise within the framework of a global recovery of world trade. This leads us to deduce that the current upswing is mainly due to expansive monetary policy.
Baltic indices since 1999
Sources: Datastream, Erste Group Research
The effects of the high oil price will soon feed through to the economic bottom line. According to the IEA the OECD nations spent USD 790bn on oil imports in 2010, i.e. USD 200bn more than in 2009. Jeff Rubin contends that the oil price increase in 2008 triggered the financial crisis and that the mortgage crisis was only a symptom of the high oil price. According to Rubin, high oil prices caused four out of the five most recent global recessions. This was on the one hand due to consumption, which is affected by the oil price, and on the other hand by the transfer of assets to exporting nations. For example, the transfer of petrodollars in 2008 amounted to USD 700bn in 2008, 400bn of which were going to OPEC nations.
The illusion of a “low” oil price is probably based on the fact that many market participants regard the all-time-high of USD 147 in 2008 as benchmark. At its current level the oil price is more than 200% above its long-term average of USD 32.6. Even adjusted for inflation, oil is anything but cheap. At USD 35/barrel on an inflation-adjusted basis, oil is traded clearly above its long-term average of USD 16.6/barrel. In other words, oil is expensive in a historical comparison, neither nominally nor adjusted for inflation.
Real vs. inflation-adjusted average price since 1982
Sources: Datastream, Erste Group Research, sharelynx.com, Bloomberg
The long-term comparison also reveals the fact that the oil price is traded close to its 150-year inflation-adjusted all-time-high.
Oil price 1861 to 2010 (in USD, 2009 = 100)
Sources: BP Statistical Review 2010, Erste Group Research
An increase in the oil price tends to affect the economy with a time lag of several months. According to a rule of thumb, an increase in the oil price of 10% causes the GDP to fall by about 25bps. Since the announcement of QE2, the petrol price has risen by 22%. Petrol has increased above the important mark of USD 3 per gallon for the first time since October 2008 again in the USA. The high price feels like an additional tax to the US consumers. An increase in the price of 10 cents per gallon translates into a burden of USD 14bn per year for the US households. This means that an increase to USD 4 per gallon would put a burden of almost USD 70bn on US consumption. Many indicators – among them the relatively obvious weakness of the retail index in comparison with the S&P 500 index as well as the still extremely negative ABC consumer confidence – suggest that “Joe on the street” can already feel the consequences of the price rise.
Petrol price USA (USD per gallon)
According to the IEA the amount spent on oil accounted for 4.1% of global GDP in 2010. Should the price increase above USD 100 in 2011 on a sustainable basis, the percentage would probably rise to 5%, which, from a historical point of view, has always been a critical level for the economy. At an average price of USD 120/barrel of Brent this would account for 6% of GDP, at USD 150 for 7.5%. It would therefore come with clearly negative repercussions for oil-demand and the economy in general. Therefore we do not think that OPEC would wish to nip the shoots of the economy in the bud and expect the cartel to step up production drastically, should the price rise sustainably above USD 100.
Oil price burden (% of GDP) vs. inflation-adjusted oil price 1970-2010
Sources: Datastream, OECD, Bloomberg, Erste Group Research
By. Ronald Stoeferle of Erste Group
Erste Group is the leading financial provider in the Eastern EU. More than 50,000 employees serve 17.4 million clients in 3,200 branches in 8 countries (Austria, Czech Republic, Slovakia, Romania, Hungary, Croatia, Serbia, Ukraine). As of 31 December 2010 Erste Group has reached EUR 205.9 billion in total assets, a net profit of EUR 1,015.4 million and cost-income-ratio of 48.9%.