Recent events in Egypt raise a multitude of issues. There is clearly a hope that reforms may support a move towards a more democratic state. Such a move in the Middle East’s most populous nation would be significant. At the same time, there are good reasons to be concerned regarding where the current instability in a major player in the region may take us. This is particularly true since it appears that the protest movements seen in Tunisia and Egypt could easily spill over into other Arab autocracies. A stable move towards democratic reforms is far from guaranteed.
However, underlying these greater concerns, one lesson is crystal clear. The global economic cycle is far too exposed to the price of one, single strategic commodity. Oil. This is greatly disruptive and creates a situation in which the global economy’s prospects are far too exposed to developments in the Middle East – the single most unstable geographical region on the planet.
More often than not, energy policy is discussed with regard to either climate change or national security issues. Both are important. However, it is also the case that volatility in the price of oil alone will have a great cost in terms of growth and employment as long as it is allowed to maintain its current monopoly position in the global transport sector.
So how large of an impact can a significant increase in the price of oil have? Methodologies and results in this area have been greatly debated. However, two of the most significant comprehensive studies of the impact of changes in the oil price on the US economy are the EIA’s 2006 ‘Economic Effects of High Oil Prices’ and the 2008 Federal Reserve Bank of St Louis study ‘Oil and the US Macroeconomy’ (pdf).
The EIA’s 2006 study of course does not take account of the negative impact of high oil prices before and during the recent Great Recession. However, it nevertheless summarizes the dangers. These are clear from the table below. This compares results from three macroeconomic models, including that of the Fed, which suggest that a sustained $10 increase in oil prices from $30 to $40 (a 33% rise) would have taken around half a percent of GDP growth in year two following the price move – and added two tenths to the unemployment rate. Moreover, the EIA points to straight time-series analysis which suggests that those affects could be three times greater.
EIA Table: Macroeconomic model estimates of economic impacts from oil price increases (percent change from baseline GDP for an increase of $10 per barrel)
|Estimate||Year 1||Year 2|
|Global Insight Inc.|
|GDP Price Deflator||0.2||0.5|
|US Federal Reserve Bank|
|GDP Price Deflator||0.5||0.3|
|GDP Price Deflator||0.3||0.5|
|GDP Price Deflator||0.3||0.4|
Against these estimates of the affect of a $10 increase in the price of oil, we have seen oil trade as low as $35 and as high as $140 recently – a range of over $100. Clearly, the years since the EIA report have seen a considerable escalation in the volatility of the nominal price of oil to which the global economy has become exposed - as the chart below illustrates.
Moreover, the EIA points out that these effects would be expected to be much greater if the economy was to be faced with a sudden shock to oil prices as opposed to a more gradual move. This is precisely what the political situation in the Middle East may provide.
click to enlarge
As oil prices moved rapidly higher in 2008, the Federal Reserve Bank of St Louis concluded that:
A permanent increase in the price of crude oil to $150 per barrel by the end of 2008 could have a significant negative effect on the growth rate of real gross domestic product in the short run.
In the end, crude topped out at around $140 and the US economy suffered the Great Recession. The precise combination of factors that finally broke the back of the economy and created the financial crisis are of course numerous. However, gasoline heading towards four bucks a gallon wasn’t helping anyone pay their mortgage.
To some extent, all of this is of course stating the obvious. However, perhaps it is time we therefore draw the obvious conclusions – primarily that there is a clear need to break oil’s monopoly in the global transport sector.
It is difficult to predict what will happen next in Egypt. However, it is fairly easy to predict that what we have here is the injection of another bout of political risk into the price of oil. Whatever the price developments over the next week or so this uncertainty will no doubt over time only spur a move in oil back towards $140 a barrel or higher this year. For those focused on crude USO, the most liquid crude oil ETF, will no doubt be higher six months from now.
All of this draws clear focus on President Obama’s call for a ‘sputnik’ moment for clean technology. I discussed my thoughts on this at more length in my recent article on his speech. In my mind, the US clearly needs to implement an Open Fuel Standard for new cars and support the build out of the infrastructure required to ensure the availability of ethanol E85 and other biofuels at the pumps as they become available through new innovation.
Energy Secretary Chu has indicated that it would cost little more than $100 per car to ensure that each new car sold in America can take gasoline, ethanol or other biofuels. That would allow genuine competition at the pumps. Adding the electric car and FlexFuel PHEVs which can both be recharged at the socket and refueled with a variety of liquid fuels would obviously over a number of years bring an end to oil’s monopoly in this sector.
Although the President omitted to mention the Natural Gas Act in his recent speech, the events in the Middle East may also bring back attention to the benefits of switching the nation’s trucking fleet increasingly over to Natural Gas.
The President also covered Electricity Generation in his broad proposals. Of course, oil is no longer a major contributor in the power generation industry. However, any move towards greater use of the electric car will require the generation of cleaner electricity and the reduced use of dirty coal. Hence, the President's plans for a Clean Energy Standard.
How to play this for now? Clearly, as oil moves higher, this will put initial pressure on stocks – and clean technology stocks may initially suffer due to general market risk. However, if you are willing to take the long view and sit through the potential volatility, there is a clear opportunity here for clean technology.
Finally, which clean tech stocks? In solar – First Solar (FSLR) and SunPower (SPWRA). In wind – Vestas (OTC:VWDRY) and American Superconductor (AMSC). In biofuels my preference is Pacific Ethanol (PEIX). For the electric car there are plenty – at these prices I like A123 Systems (AONE). And if the Natural Gas Act gets a second wind, the main beneficiaries will be Clean Energy Fuels (CLNE) and Westport Innovations (WPRT). I have written about all of these stocks in more detail over the past couple of months. The path ahead may well be rocky. However, a year from now I believe that a blended portfolio of these stocks will be significantly higher.