No-one talks about the part oil price surges played in the 2008/9 global financial crisis

Welshcake

welshcake@acuris.com

Investors eyeing inflation shocks and supply chain disruption should instead be paying attention to the brewing energy crisis

There are few sights less savoury to a Welshman than hordes of red-faced English types pouring over the border to siphon into jerry cans the land of our fathers’ precious fuel. Such were the scenes recently as logistics problems and media panic coupled with the inborn avarice of the Saes.

But it’s even worse when you are holed up with covid-19 and can’t go outside to fight them. Yes, after 18 months of dodging covid it finally got me in a momentary lapse of misanthropy. The vaccines did their work, thankfully, and I was soon ready to take a halberd down to the petrol station.

Finding those English weasels had hastened a retreat, I visited the cinema instead. “I must not fear. Fear is the mind-killer,” is a Frank Herbert line retained in the scripts of both David Lynch’s film ‘Dune’ and the new Dennis Villeneuve version.

The story’s premise has big relevance to the world we must seek to navigate as we move from 2021 to 2022. Fear is a hard sentiment to ignore at this juncture if you are a fixed income investor. But whereas inflation, asset tapering and rate rises hold most focus, my own concerns are increasingly turning to an energy crisis that threatens elements of both 2008 and the 1970s.

Arguably, oil price surges and inflation shocks are adjacent problems. However, it’s overlooked how big a contribution the former made to past recessions. Oil was in fact central to GDP loss in most cases, yet no-one much talks about the part it played in the 2008/9 global financial crisis.

WTI oil prices steepened sharply from 2007 to an all-time high of $145 a barrel by 3 July 2008. This hit the auto industry hard through diminished sales of first SUVs and then cars more broadly. It also dampened overall consumer spending and sentiment, as with previous oil shocks.

Pundits only speak of the financial crisis these days in terms of subprime mortgage and synthetic credit weapons of mass destruction. But back then oil prices were a distinguishing factor in the US between rising house prices close to central urban areas and falling prices at longer commuting distances. This translated into differing foreclosure rates as the crisis unfolded, while oil prices also cut income and increased unemployment.

Speculation through oil futures contracts exacerbated the 2008 price run-up, but at a fundamental level it resulted from strong demand driven then as now by China’s growing need. Oil production was quite stable throughout the early 2000s, but failed to keep pace between 2005 and 2007. This highlighted the world’s over-reliance on Saudi Arabia to meet shortfalls in the face of declining rates elsewhere.

Compare and contrast this spike and subsequent plummet of oil with the 1970s crisis, which was prompted by supply disruption. That brought stock market crashes, soaring inflation, high unemployment and, ultimately, the early demise of governments in both the US and UK. The 1970s energy costs and food shortages fed into a UK inflation rate that eventually hit 24%. An almighty political battle over wages ensued and WTI hit $40 a barrel by the end of that decade, or over $100 in today’s money.

Is oil as powerful as it was?

Fast-forward to 2021. In this age of ESG it is natural to query whether oil still holds the same power to dent GDP. Yet it is precisely the failure of governments to match rhetoric and ideals to practical application that makes today’s crisis particularly acute. We face heartbreaking evidence of how much some took their feet off the pedal in this shift to alternative sources during the covid pandemic. The supply chain blockages that greet reopening expose painful ironies in how Germany neglected to replace decommissioned nuclear power plants and Brazil created an ecological own goal through its hydro-electric ambitions.

Beyond crypto enthusiasts, there’s no reason anyone should post with glee how bitcoin remaps gold’s progress in the 1970s. This only indicates the trouble we’re in, as the persistence of extreme prices implies a bigger flight to safety and ensuing crash. And even bitcoiners won’t be smiling if another Texas energy crisis this winter stymies the mining effort. He who controls the spice may control the universe, but the coming months should be a big wake-up call that alternative energy is more than just an environmental matter.

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Global credit funds & CLO's

November 2021 | Issue 240

Published in London & New York.