Oil could put the economy in check

For the first time in a year, oil prices are approaching $ 60 a barrel. A very remarkable growth in just four months, which threatens the economic recovery.

The last time we focused our eyes on oil, and taking into account its evolution, we must remember that we were talking about a scenario in which, in the midst of a pandemic, futures on barrels of crude oil were trading negative for the first time in their history. The lag caused by the pandemic, very visual in the analysis (here) offered by colleagues José Francisco López and Andrés Sevilla of supply and demand, caused something that had never happened. A situation in which producers, or traders, paid buyers to “take the oil off their hands.”

As we said, the paralysis that the economy was experiencing in 2020 due to the pandemic makes it necessary to look through the history books to find precedents, in times of war, in which a similar paralysis has occurred. This situation forced the oil-producing countries, which make up the cartel we call OPEC, to reduce production in order to achieve market equilibrium and, in this way, contain prices. However, the cut applied, of -9.7 million barrels per day, could not be adjusted with a demand that, according to The Economist, was reduced by -29 million barrels a day.

This situation caused a steep drop in barrel prices, as demand fell, as the colleagues well defined, by more than a third worldwide; not being able to adjust, later, the relationship between the forces. However, the resumption of economic activity in recent weeks, together with the reduction in supply, has caused the price of a barrel to approach 60 dollars. An increase that, despite being beneficial for the cartel member countries, threatens economic recovery.

The close relationship between energy and economy

“As we see, energy is, and never better said, the fuel that makes economic activity possible.”

Before the economist Simon Kuznets coined, at the request of President Roosevelt, a system to measure the economic growth of countries, which we call gross domestic product (GDP), we must know that one of the most used forms, with which economists counted to measure economic growth, as well as population growth, it was energy consumption or energy consumption. Well, despite the fact that we did not have sophisticated indicators that showed aggregate production in a country, we could guess that said production could have been higher or lower, depending on a higher or lower energy consumption.

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In other words, the higher the energy consumption, the higher the production obtained. A rule that does not always have to be followed, but that, in order to understand what we are commenting on, we explain it like this.

However, it is not necessary to go back to homo economicus, or to such ancient stages of history to realize the close relationship that energy and economy have always had. And it is that, as the economic historians themselves have defined, the reason, precisely, that the United Kingdom led the race of the Industrial Revolution in Europe is due, among other things, to the energy resources that this country had at that time . Well, at a time when coal was positioned as the most widely used fossil fuel of the time, the United Kingdom was positioned as one of the largest producers worldwide. A situation that made the Anglo-Saxon country a leading country at a key moment in history.

We are also talking about a situation that, in the same way, we see today. In this sense, economies such as Spain are fully conditioned to the arrival of fuels from abroad, since they present what is known as “energy dependence”. That is, they do not generate energy to supply themselves. Thus, such is the degree of this dependence that, by eliminating it from the trade balance, that is, by eliminating the import of fossil fuels from said equation, the balance that the Spanish trade balance would show would not only be positive, but would also show a trade surplus , never seen, incidentally, in its historical series.

As we can see, energy is, and never better said, the fuel that makes economic activity possible. Both for the economic growth of the population in the past, and for the arrival of the Industrial Revolution in Europe and other territories, and even for the growth of economies, which need it to operate. For this reason, energy is a determining element in economics. And I say decisive due to the fact that these variations that we collect today in prices, precisely, can benefit these producing countries, but harm those that do not have these energy resources and must import them from abroad. All this, in addition to the damage suffered by socioeconomic agents, who have lower purchasing power.

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Risks on the horizon

“An increase of 20 dollars in the price of a barrel generates, de facto, an additional cost of close to 50,000 million euros per year that the EU countries will have to pay.”

According to data provided by Bloomberg, oil prices have skyrocketed over the past two months.

To be more precise, we are talking about a value that has gone from being below 40 dollars per barrel in the month of October, to being, at the moment, a few cents of 60 dollars per barrel. Thus, we are facing an increase of more than 60% in a matter of four months. The resumption of economic activity in the West, in a scenario in which oil producers, fearful of a possible low demand and a fall in price, have frozen production, is causing, as in past oil crises, an inflation in the price of energy.

As we mentioned before, and taking into account that oil is the most widely used fossil fuel in the world, the production of different countries depends on energy and, therefore, their economic growth. Therefore, an energy surcharge, in the same way, will force those most dependent countries to allocate more resources to the cost of energy, which, simultaneously, will reduce the possibility of allocating these same resources to generate greater production. In other words, an energy cost that could limit the growth of those most dependent economies.

This is the case in many countries in the European Union. Taking into account that oil imports by the countries of the European Union reach 8 million barrels per day, a scenario in which there is an increase of 20 dollars per barrel causes, de facto, an extra cost of close to 50,000 million euros per year. A worrying situation, because in the face of a crisis of such outstanding dimensions and at a time when we must recover, a growth in the price of energy could stifle demand and delay this recovery.

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Thus, countries are in a difficult situation. Weak demand in the recovery adds to an increase in energy costs that could weaken it further. A sustained increase in the price could lead to a lower capacity of certain countries to recover the previous levels of demand that they need, precisely to get out of the obstacle in which they are today. For this reason, the restrictions applied by these countries, and which not only sustain, but also raise the cost of energy, put in trouble some productive fabrics that are forced to allocate more resources to the cost of energy, in a scenario in which they are also they are very undercapitalized.

For this reason, and ultimately, we must know that, apart from European aid, the risks posed by the recovery and apart from all these events, energy prices are another risk from which the different economies, and especially the most dependent, should be aware. Well, if there was a situation that the economy should fear, it is stagflation. A phenomenon that, due to weak growth and the increase in prices, in past crises such as those of oil, in ’73 and ’79, caused serious headaches in many economies throughout the planet.

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