Date: July 8, 2014

No Inflation Seen in Energy Prices

With the various global tensions impacting the energy market, I thought it was appropriate to write a few articles about crude oil and how viewing different time horizons yield very different opinions. This is part I to be followed by part II next week.

To begin with, energy and more specifically, crude oil, has an enormous impact on the global economy. From common sense items like heating our homes and powering our cars to more derivative things like chemicals and asphalt, crude oil is a vital ingredient in the global economy.

It still seems like yesterday that the pundits confidently proclaimed oil above $40 a barrel would cause a severe recession and $75 would spell depression. That was when Iraq invaded Kuwait in 1990 and of course, they were wrong. From its generational bottom at $10.65 in 1998, oil almost quadrupled by mid 2000 without any economic pause.

From the post 9-11 low at $17, oil once again quadrupled by 2006 to $78.40. And again, there was no economic slowdown let alone recession, save depression! It wasn’t until oil went parabolic in 2008, straight to $147 that, combined with the financial crisis, spelled doom for the economy.

What’s the takeaway from this very basic and brief study of energy prices?

*As we have seen since 1990, higher oil prices do not equal higher inflation.

*Runaway oil prices over a period of time don’t equate to a recession.

*Third and perhaps most important, in my opinion, the American consumer is very able to cope with higher energy prices as long as they occur over time and not in the form of a shock. Obviously, if gas was $10 a gallon, that would severely impact the economy, but $100 oil did not stop the global economy and I would argue that if the financial crisis was not unfolding, the economy may have paused and perhaps even mildly recessed, but it would not have collapsed solely due to oil prices.

Today, I am often asked where I believe crude oil is headed and at what level we should worry that the economy will be adversely impacted. First, it certainly looks like oil is headed higher, right from here at $104. Oil traded to fresh 2014 highs last month and is now resting. Once $108 is exceeded $115 should be next before long. That level is really the “put up or shut up” spot for energy and as a consumer, my “hope” is that the rally ends there. Surpassing $115 opens the door to some much higher scenarios that most of us do not want to see!

If you would like to be notified by email when a new post is made here, please sign up, HERE.


Paul Schatz, President, Heritage Capital