The oil crisis of the 1970s is the last supply ‘shock’ in memory

The current increase in the cost of energy, mainly due to the rise in gas, which has dragged down oil and other raw materials, known as bottlenecks in the supply chains of industries, with the shortage of chips as the main problem in the global productive supply and with the automobile sector as one of the most damaged, and the acceleration of inflation in recent months are consequences of the coronavirus pandemic that are showing that the global economy does not have a button to automatically restart, as would have been the ideal after the hibernation of the activity to contain the historic health crisis of 2020.

The tension shown by these three factors responds to a supply shock very different from the shock received by demand in the Great Financial Crisis that originated in 2008 and is derived from the rapid recovery – in V, in many respects, and in K, with winners and losers in others- of the Covid recession due to its particularities, such as excess savings accumulated by families during confinement or as the extraordinary response of monetary and fiscal institutions, with extensive stimulus programs such as debt purchases of the European Central Bank (ECB), the Next Generation fund of the European Commission or the budgetary effort to protect employment, only in the euro area, with similar aftershocks in the United States and in most developed countries.

The last supply crisis that could become comparable to the current one is that of oil in the 1970s. And rescuing its aftermath from historiography terrifies the market: Wall Street sank 50% from the maximum recorded in the S&P 500, the benchmark, January 11, 1973, through October 4, 1974 floor; Crude oil soared, inflation passed the hyperinflation line with peaks of 14% in 1980.

The current evolution of headline inflation is still a long way from the rise in the CPI in the United States and in most Western countries during the oil crisis, which had its origin in a serious geopolitical conflict: it began on October 16, 1973 , following the decision of OPEC (Organization of Arab Oil Exporting Countries) not to export more oil to the countries that had supported Israel during the Yom Kippur war (named after the Jewish commemorative date), which faced Israel with Syria and Egypt.

On this occasion, with the arrival of vaccination, the economic recovery has been indeed strong and, little by little, the world is returning to normal. Thus, the situation in the energy market and in other sectors such as chips or transportation has generated a significant imbalance, due to a strong increase in demand that supply is not being able to satisfy.

For oil, the key is what is happening with natural gas, which has also increased geopolitical tension, with Russia regaining a leading role in the world and China accumulating reserves of this and other materials to prevent the risks faced by its industry. The price of this basic resource has skyrocketed in recent months, much more than that of crude oil (so far this year the price of reference natural gas in Europe has risen more than 400%).

This, however, is beginning to be passed on to the price of a barrel, which receives more and more demand as a substitute. Futures traded on Brent crude have rebounded 65% from the lows of the coronavirus pandemic in April, when they entered negative territory.

Energy crisis

And the cost of energy as a whole (oil, especially gas, coal, green generation, hydroelectric or nuclear) as a percentage of global economic activity reaches maximums of the Great Financial Crisis of 2008 – about 9% – and points to peaks of the oil crisis of the 1970s – at 10%, as calculated by Citi in a recent report. Exactly “it is almost four points above normal,” observes the team of analysts at the investment firm of the North American bank, in reference to the average of the last decades (see graph).

The script for the energy crisis has developed over several episodes. At first, the power shortage in China was due? the high electricity load that occurs in summer and the limitation of the national coal supply, boosting imports and draining world energy markets.

Then, natural gas storage in Europe remained in deficit, with gas imports from abroad and in particular from Russia below normal levels. This fed? fears of a possible shortage in the coming winter with the rebound in heating consumption, causing a brutal takeoff in prices. More recently, oil-producing countries seem to be taking advantage of their temporary power to act on the market, maintaining a slow path of reduction in supply and fueling higher prices. “This fierce market dynamics appears to be characteristic of the usual bubbling around cycle peaks. Prices should cool down later this year as the market’s self-healing mechanisms have kicked in,” says Yves Bonzon, Julius Baer’s strategist.

China and Russia, protagonists

“We see current oil prices as a reflection of the policy of OPEC and its partners to stick to increases in existing supply and rising gas as a result of China’s accumulation, which undoubtedly represents a a real headwind for the global economy, “Citi experts continue. “Of course, there are already strong signs of an impact on demand, with parts of the Asian industry forced to cut production and also in Europe,” they add.

BofA analysts note in another report that “energy prices also create downside risks to growth and inflation.” In addition, in his opinion, “although there is much talk about the consumer, companies can suffer a lot: the recent rise in the price of natural gas alone could reduce operating profits by 1.5% this year and 2.4% next year” . They also point out that “a K-shaped recovery could put the lowest income groups with the least savings under special pressure if there is no political response.”

“Currently, the energy crisis is developing day by day, and the negative effects on GDP for the second half of 2021 will already be important. Will the situation get even worse during the winter? The short answer is yes”, insist Nordea .

Temporary peak?

Some analyzes that imply inflation without growth, the dreaded stagflation. One of the worst scenarios in which the global economy can enter is currently debated, with the shadow of the oil crisis as a milestone that no one in the market wants to think about. “It is likely that we will continue to see this high inflation and probably well into 2022,” says Nicole Webb, vice president of Wealth Enhancement Group.

This opinion is spreading, and it is a position that expects the Fed to begin reducing monetary stimulus from next month and to study the increases in official interest rates earlier than expected. A path that would follow after the ECB, and that will be followed by the rest of the monetary institutions.

From within the Fed itself, the president of the Bank of Saint Louis, James Bullard, pointed out this week that there is a 50% chance that pressures on prices will persist, coinciding with other important voices of the US body.

“For years in the West we have been driving economic growth by stimulating demand, and now we are faced with a supply problem. Paradoxes of life”, reflects the team of analysts at Portocolom AV. “The absence of investment in certain sectors and for very different reasons in recent years is leading to significant restrictions and bottlenecks on the supply side,” he continues, and ends: “Many have had to dust off the macroeconomics books to check the short-term inelasticity of supply (in the face of price rises, the quantity of supply is not increased) in certain sectors. And faced with this problem, central banks can do little. Moreover, to curb inflation it would require policy measures monetary policy totally contrary to the views in the last decade.

“A change of scene at a global level, which also puts an end (at least temporarily) to the complacency that we have been enjoying in recent months”, they conclude in Portocolom AV.

“A prolongation of the current peak of inflation could increase the risks of more secondary effects that turn the price shock into an upward change in the inflation regime,” warns Gilles Moëc, chief economist at AXA IM. “On the contrary, even if the inflationary shock takes longer to disappear, despite all the discomfort it would cause in central banks, it would not necessarily mean an appropriate upward change in the inflationary regime. For this to happen, wages must respond on impact “, Moëc ends.