Previous Oil Shocks May Offer a Predictor for Future Energy Prices
By comparison, the next two shocks, involving U.S. conflicts with Iraq in 1990 and 2003, were less severe. They resulted in a doubling of oil prices, but inflation did not accelerate materially, and the Federal Reserve refrained from tightening monetary policy.
The prevailing view among economists last year was that the impact of Russia-Ukraine fighting on energy prices would be similar to the U.S. conflicts with Iraq. Some energy experts anticipated that the price of West Texas Intermediate would nearly double to $125-$150 per barrel and that natural gas prices would increase even more due to Europe’s heavy dependence on Russian supplies.
But the price for crude oil subsequently fell steadily from $120 per barrel in June, and it is currently hovering around $70 per barrel. Even more surprising has been the steep drop in the benchmark price for natural gas in Europe. It has plummeted from a peak of $70 per million metric thermal unit in August to around $20 recently.
What Factors are Impacting Oil Prices?
Looking ahead, it is unlikely that energy prices will decline much further, barring a global recession. It’s clear Western economies have adapted much better than expected to shortfalls resulting from the conflict.
Escalation of War is Biggest Threat Currently
This does not mean that the conflict no longer poses a risk for the global economy and markets. Rather, the nature of the risk has evolved from the impact on energy to the threat that the war could escalate.
Initially, most observers believed Russian troops would overwhelm Ukraine and the fighting would end quickly. Now, there is realization that it will be long and drawn out as Russian President Vladimir Putin tests the West’s resolve in assisting Ukraine.
Russia’s unexpected military ineptitude and shocking cruelty have pulled the U.S. and NATO allies deeper into the conflict to the point where Ukraine is now the West’s war. The result is that they are increasingly compelled to provide a massive program of military assistance to break the impasse. The hope is that Ukraine will be able to capture the offensive in spring and retake ground that will enhance its bargaining position.
Is Chinese Intervention on the Horizon?
Thus far, China has been reluctant to offer Russia its direct support for several reasons. One is that it may not want to be seen backing Russia if it thinks it will not prevail. Another is that China’s government is aware that it could face U.S. sanctions on trade and finance. Because China is much more closely integrated with the West than Russia, its economy would suffer if there were a disruption in international trade and finance.
Biden recently stated that he did not threaten China with sanctions. But, he reminded President Xi Jinping of the number of U.S. companies that have opted to close their operations. According to a Yale School of Management report, over 1,000 companies have curtailed their operations in Russia, although some remain.
How are Investors Impacted by the Conflict?
The ability of Ukraine or Russia to maintain an arsenal of weapons may dictate the outcome. So, where does this leave investors today?
Previously, investors could focus on how energy markets were reacting to the conflict, and they could assign probabilities to possible outcomes in making risk-reward assessments. But as the conflict has evolved over the past year, investors now must consider the geopolitical consequences of an escalation of the war. Because the outcome is highly complex, it is more difficult to assign probabilities to them, and we now live in a more uncertain world.
Faced with this situation, investors may shrug their shoulders and ignore the possibility of the war escalating, or they may choose to lessen risk in their portfolios by adding cash or gold to their positions. While the correct stance is not obvious, one thing is: This is not a time to add risk to investment portfolios, especially with the Federal Reserve poised to tighten monetary policy further.
A version of this article was posted to TheHill.com on March 9, 2023.
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