Oil - The Piano Overhead

The US economy will do quite well through H2.

There is however a significant wild card; that would be crude oil and the translation to gasoline prices over the intermediate term. This is the only potential retardant with enough potency to bring us to a sudden halt.

Every economist on Wall St has a nifty little model translating crude, and, or gasoline prices to economic activity. Because these models are rigid, fixed, because they do not account for consumer attitude at the time of energy price change, they rarely work.


Background:  Return to early 2011. Economists had just finished writing off Q4 ’10 activity when in fact it blew through estimates and came in at 2.3% (not strong in the literal sense, but that is not our point in this discussion).  Having been thus flattened, after dusting themselves off they rushed in the other direction, predicting great things for H1.

We wrote in early March that the Mid East (along with interventionist Fed policy) would act as a significant retardant and that H1 growth would come far inside of consensus.

When WTI printed 99 on Feb/23 (Libya) observers were not a bit worried. We said then that the course-of-least resistance for crude would remain higher over the intermediate term and that it would sap the consumer. By Mar/24, May WTI printed 106.69.  Still, Street observers remained in a trance, not shaving their estimates for GDP or consumption.

On Mar/26 we predicted a 120 high-side target, this tagged to potential Saudi / Iranian armed conflict. All the while, there were signs of slower consumption, but they went unnoticed by the willfully blind.

May/2 saw 114.65 on the near contract, WTI, the day after Bin Laden was killed. That was it.  Close enough to kick the legs out from under US momentum. With the translation to gasoline prices, and key – the sensationalist press that went with the Arab Spring, this and what had come before it was enough to stop consumption dead in its tracks. Retail sales collapsed Q2.

We could experience a repeat.  That is, we could experience a major slowdown in the US real sector; not for reasons now imagined, but for oil.

There is no guide and nor model to run to for help. We have to decide contemporaneously; every situation is different. Pressure on crude (much of it supply related, including a strike in Yemen, a Syria pipeline explosion, shenanigans in Sudan and the Iranian cut off to six EU states) represents the piano overhead for the US consumer.

Today we are paying $3.85 for gasoline on the west coast of the US and this just weeks before refineries typically shut down for springtime maintenance, just weeks before the states switch from their less expensive winter blends to more complicated and pricier summer blends. Feb crude prices are higher than they have ever been before on similar calendar dates, past years.  And we understand that a number of refineries were permanently closed in the last six months, refineries which represented the key to a smooth spring transition.  All of this means any higher crude will be translated to gasoline in a hurry, at warp speed.

Four dollar gasoline for even three weeks will slow the consumer; five dollars per gallon would stop the consumer dead in his tracks and put US growth at zero. And we could get there is a jiffy.  Iranian-birthed tension will intensify over the next few weeks, and that, thanks to an inept US administration. Obama is now trying to play catch up after his failed appeasement strategy. Now the sanctions finally have teeth. The EU has followed by pledging to stop imports from July 1.

Next, due to Obama’s hostility towards Israel we have much less idea what it may be up to, and much less influence than before.

Finally, the long-appeased Iranian theocracy is now more likely to miscalculate; thinking either that the confused Obama administration won’t stop it, or that any American attempt to stop it would be only half hearted. Hope resides in an uprising within the country, the masses feeling enough pain to throw out the troglodytes.  (They tried just that two years ago but were abandoned by the US.)  Short of such an outcome, violence is almost certain.

Robert Craven