(Reuters) – Why have global equity markets been so resilient to the Iran oil shock? Because $100 a barrel oil doesn’t mean what it used to. Brent crude has risen around 70% since the Iran war began on February 28 to over $120 per barrel, as of early Thursday. Yet global equity markets, though volatile, are still substantially back above pre-war levels. While there are many explanations, the key one is rooted in math. The head of the International Energy Agency, Fatih Birol, has described the current oil shock as the worst-ever – more serious than the ones in 1973, 1979 or 2022. He points out that the war and closure of the Strait of Hormuz have disrupted some 12 million barrels per day (bpd) of crude oil supply. Other energy shipments have been hampered too. This compares with 5 million bpd of losses related to the OPEC embargo in 1973, making this “the most severe oil shock ever,” Birol says. However, if we adjust for inflation and energy consumption as a percentage of gross domestic product, then the oil shock – both in terms of supply destruction and price increases – does not look nearly as severe – and equity markets’ resilience appears a lot more reasonable.
THE DENOMINATOR MATTERS
To begin, the size of the supply destruction ought to be assessed with the correct denominator and not be compared across time in absolute terms. Back in the early 1970s, global consumption of oil was around 50 million bpd, compared with double that before the Iran war, according to the IEA. So 5 million bpd meant a lot more back then. Next, the global economy has become less oil intensive. While global oil consumption, measured in millions of barrels, has risen over time, it has collapsed as a percentage of GDP – a measure known as the “oil intensity.” This ratio is currently about a third of what it was in 1973, according to the U.S. Bureau of Labor Statistics. Also, to compare oil shocks across decades, one needs to account for inflation itself, which in the U.S. has risen some 650% since the early 1970s.
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Adjusting for inflation and the use of oil as a percentage of GDP, our econometric estimates suggest that $100 a barrel today is equivalent to around $50 before the Global Financial Crisis or roughly $5 in 1973.
U.S. EXCEPTIONALISM
The U.S. economy, in particular, appears to have become much less vulnerable to an oil shock of this size. Our analysis, based on the assumptions above, indicates that while a 50% crude oil price shock in the 1970s had a negative 1.0% impact on U.S. GDP over eight quarters, it would likely only have a negative 0.2% impact at present. Similarly, our analysis implies that the impact of big oil price shocks on U.S. inflation may have declined to a quarter of the level seen five decades ago.
The U.S. also now appears better positioned than other regions. Oil price increases have negative multiplier effects on real – inflation-adjusted – economies, but these multipliers vary across countries.
Strikingly, the U.S. is now half as sensitive to oil price increases as Europe or Asia, based on our econometric estimates. This gap has risen over time as the U.S. has become broadly self-sufficient in hydrocarbon fuels, as a result of the shale boom.
Energy prices are no doubt still crucial to the U.S. economy, but the sectors that are most sensitive to energy prices, like manufacturing, have become a smaller portion of the overall U.S. economy as the services sector has grown.
STRONG FUNDAMENTALS
It’s good to remember that the global economy – and the U.S. economy in particular – was pretty robust prior to the start of the Iran war.
That’s partly thanks to the massive transfers from the public sector to the private sector during the COVID-19 pandemic. This government largesse significantly improved the financial standing of households and companies in many major economies. Next, the tech race and the gargantuan associated capital expenditures – mostly in the U.S. and China – continue to propel the global economy forward. A world with greater competition between global powers – far from weighing on activity – is apt to generate more economic growth than a world driven by cooperation – at least if history is any guide.
I am, of course, not arguing that high oil prices have zero effect on economic growth, inflation or asset prices. If crude prices were to spike much higher – say, closer to $200 – then we could see U.S. and global recession risk overwhelm inflation concerns, leading to lower equity prices, a stronger dollar and lower bond yields. But, overall, the tolerance of the global economy to oil shocks may be substantially higher than some think. As long as oil prices remain broadly range-bound, there is little reason to expect current market trends to reverse.
The views expressed here are those of Stephen Jen, the CEO and co-CIO of Eurizon SLJ asset management.
Writing by Stephen Jen; Editing by Anna Szymanski and Marguerita Choy
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