Sunday, January 30, 2011

Watching Egypt

 The price of Crude Oil  skyrocketed Friday as all eyes were turned to the drama in Egypt.
My experience has been that the THREAT of supply disruption is responsible for price spikes. In the actual event oil always finds it's way to the market. The overthrow of the Shah of Iran may have spiked oil to $40 but it sold off from 1980 to 1986, from $40 to $9.75, despite the 1980 to 1988 Iran-Iraq War.
The 1st Gulf War saw it's highest price point, $40, in Oct of 1990, (note it did not exceed the 1980 high) well before military action by the  United States, and it came off those highs rather quickly, eventually falling to $12.50 in '93 .  So during these periods of major armed conflict in the richest oil producing areas, prices actually came DOWN.
The Iraq War began in Mar of '03, WTI peaked at $41 in the last week of Feb. prior to the start of hostilities and promptly fell to $26, where it basically stayed for the next 6 mo. (The subsequent price rally to historic highs of 147 in 2008 is arguably a result of monetary stimulus.)
Again the THREAT of supply disruption causes the spike.

The first and last order of business with any government new or otherwise, is continuation of the cash flow.

Most likely Fridays spike was speculative momo buying and tail risk covering as reported by Bloomberg
and  Mish in Oil ETF Call Trades Soar to Record, Crude Futures Back Near Highs; What Will Next Week Bring?


Oil price spikes as a result of geopolitical upheaval are very quickly worked out. In fact there is a good argument to be made that the short term effect of rapid increases at the pump destroys consumer demand longer term. Hence the prolonged declines in price that follow. See
Oil Shocks and Aggregate Macroeconomic Behavior:
The Role of Monetary Policy*
BTW The above paper references Ben Bernanke's 1997 paper on same topic...guess what his solution is?

The  unrest in the Middle East this year has been triggered by the rapid increase in food prices. . All of the countries affected have limited freedom of expression and authoritarian leadership protecting the status quo. Their large populations of unemployed or poorly compensated are particularly hard hit by inflation and rising food prices. Does this profile bring any other countries to mind?
Food accounts for 40% of the average Chinese household budget.
From Econoforcast; China vs. Inflation: A Love-30 Match So Far
"The prices of food was up 7.2% year-on-year in 2010, just based on the official number. Meanwhile, various news reports indicate that the food price inflation in China is actually running in double digits, and the government had to release strategic grain reserves just to keep a lid on prices."

One thing we can be sure of, China is watching Egypt very very closely.  Renewed efforts to contain inflation and slow down China's economy are certain.

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