A number of analysts are pointing out that oil prices may have moved up too quickly and the move is potentially unjustified. These price increases (with a large move today alone – see chart below) have been driven by two factors:
1. The Greek “resolution” may be pointing to a global economic stabilization that will increase demand.
2. Iran’s belligerent attitude and nuclear ambitions are creating fears of supply disruptions.
Let’s address both of these items.
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| Today’s move in Brent crude |
1. The Greek resolution still has numerous risks even if the deal closes. But that’s not the real issue. People forget just how broken the Eurozone’ financial system is. Credit is extraordinarily tight, bank deleveraging has only just begun, and the dependence on central bank financing will take a long time to heal. A Eurozone-wide recession is inevitable and with that will come a reduction in oil consumption (as the chart below from Capital Economics shows.) With slower growth expected across BRIC nations as well, the GDP “stabilization” is not likely to support large increases in demand for oil.
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| EU GDP (with forecast by Capital Economics) vs. EU oil consumption |
2. China and India, the only large customers for Iranian oil now have that nation in a vice. The only reason to buy from Iran and risk upsetting the US and EU is obtaining a material discount. China and India can always wait and buy crude at market prices elsewhere, but Iran cannot afford to forego critical oil revenues for very long. It will cave in and sell what it can to India and China at rock bottom prices – its revenues deteriorating further.
In the mean time Iran is struggling to pay for the food imports the population desperately needs. Many Middle Eastern brokers who sell gran to Iran have not been paid and food cargo ships are not unloading. Domestic inflation is out of control. The official numbers point to inflation that is now above 20%.
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| Iran official YOY CPI (Bloomberg) |
This is in fact consistent with the latest numbers from the CIA:
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