Who Survives $200 Oil and Who Doesn't

The Strait of Hormuz is completely shut off because of the war in the Middle East. Next, 20 percent of the world’s oil supply, 15 to 20 million barrels, vanishes into thin air. Oil prices explode to $150, $200, and beyond. These scenarios have already been run through the brightest minds at Goldman Sachs, J.P. Morgan, and the Pentagon, to the last detail.

With the current government debt load, savings rates, and the recent inflationary experience of 2021-2023, the effects of the price increase to $150 to $200 per barrel will be felt throughout every corner of the globe. Exactly how this happens is outlined in the next chapters.

The Price of Everything Goes Up at Once

Oil is the lifeblood of civilization. It’s in the price of the bread in your kitchen, the plastic wrap it’s wrapped in, the truck that brought it to your store, and the factory that made it. It’s like an invisible tax.

We have already caught a glimpse of this in the past. In the summer of 2008, oil peaked at $147 a barrel, and this caused the worst financial crisis since the Great Depression.

The math is simple. Oil has been in the range of $75 to $80 for most of 2024. If it goes to $150, it’s a simple doubling of the price. If it goes to $200, it’s almost a tripling of the price. This means an additional 3 to 5 percent inflation on already inflated prices, a recession in most of the developed world, and an impossible choice for every central banker.

Governments are left with two scenarios: to kill the economy with high interest rates and make unemployment skyrocket, or to send oil prices into the stratosphere with low interest rates.

This is stagflation: economic contraction and inflation. The only economic scenario in which none of the tools in the economic toolkit work.

Domino Effect Across Industries

Oil price shocks devastate industries in a domino effect, making each one worse than the last.

Aviation feels the first blow. Jet fuel already accounts for 20-30% of airline operating costs. If the price of crude oil is doubled, it is a death knell for airlines. Airfare goes up 30-60%, air travel stops, and discount airlines on the margin cease to exist. The big airlines survive by going to the government for bailouts, just as they did during the COVID pandemic.

The effects of high oil prices are not over yet. Hotels become ghost towns. International air travel stops. Airbus and Boeing look on in horror as new plane sales stop, as there are no passengers to fill existing planes.

Shipping delivers the 2nd wave. International freight rates go through the roof. The world will once again dismantle the supply chain that took us 2 painful years to rebuild. This time, it won’t be COVID – it will be war. Every container that crosses the Pacific or goes around the Cape will have a higher fuel surcharge. Every factory in Asia will have factored this in. And by the time these containers reach London or Los Angeles, the price will already be factored in. Even the inflation in the grocery bill will already be factored in.

The chemicals and agriculture sectors are in the middle of the energy and famine. Oil is the precursor to every single industry in the world. Plastics, fertilizers, synthetic fabrics, and medicines are all petrochemicals. If oil costs triple, then fertilizer costs will triple. If fertilizer costs go through the roof, then food costs will go through the roof. In the developed world, this means a tighter food budget. In the developing world, this means a humanitarian disaster leading to regime change.

Automotive and retail businesses will face a difficult reality. Car sales will drop through the floor for combustion engine autos, as no one wants to buy a new car with a $120 fill-up. Electric autos will get a huge psychological boost, but with this will come a drawback: the plastics, metal, and other petrochemicals required to build these autos are now also on the higher freight rate, as they are shipped on the same oil-powered container ships. Retail titans like Amazon and Walmart will discover that free shipping isn’t so free when oil prices are high. Consumer spending will now consist of food, medicine, and nothing else.

How the Oil Shock Hits Every Major Economy

An oil shock of this magnitude hit every economy differently and exposed fault lines that already exist. What follows is a breakdown of how the world’s major economies are positioned when the price of oil moves decisively toward $200 a barrel.

The US and Canada: Two Sides of the Same Barrel

On paper, the US appears to be in a prime position to be the big winner. After all, it is the largest oil-producing country in the world and has access to the Permian Basin and the shale revolution. However, in practice, things are not quite so simple because it is also the most consumption-prone economy in the world.

If oil were to rise to $150 a barrel, that means gas would rise to more than $6 or $7 a gallon. For a family that runs an SUV or a pickup truck, that means an extra $150 or $200 a month that disappears before it even reaches the table in a restaurant or the office of the mortgage broker. That’s 130 million families. Suddenly, 70 percent of the US economy, which is driven by consumers, starts to slow down. Recession becomes a guarantee.

America’s Federal Reserve, on the other hand, is in the worst possible place. Inflation shoots back up to 6-8%, and growth is already slowing down. Increasing interest rates to combat inflation will kill what is left of a dying housing market and continue squeezing corporations with massive floating-rate debt burdens. Doing nothing and allowing inflation to get out of control will destroy all of the progress the Fed made in 2022-2023 in rebuilding its credibility.

The likely result is a painful rate hold in place at painfully high levels as the Fed insists that this time is different, the shock is transitory, and the world should believe them.

One silver lining in all of this for policymakers in Washington is that the dollar will almost certainly appreciate as money flows into US treasuries in search of a safe haven in a global storm.

Canada, on the other hand, is a very different story, at least on the surface. The oil sands of Alberta, oil producers in Saskatchewan, and the pipelines in Canada overnight translate into a license to print money. The federal government is flooded with money, the Canadian dollar rises on the strength of rising commodity prices, and the TSX, which is loaded with oil stocks, does very well, far better than almost any other publicly traded stock in the world.

The problem is that Canada is not an island. More than 75% of Canada’s exports only cross one border, and that border is the border between the US and Canada. If the US were to enter a recession, Canada would feel it almost immediately. The oil money is there. However, it comes with the price of watching your biggest customer go bankrupt.

Germany Deindustrializes, Europe Pays the Price

The fact that Europe imports oil in quantities that can only be described as enormous, and has nothing even close to oil production of its own to help mitigate the effects of the coming oil shock, means that this is not going to be a shock that Europe is going to easily weather.

After 2022’s gas crisis destroyed the industrial base of the European continent, what survived has been struggling to stay afloat ever since. This means a second shock of this nature will fall squarely on a body with no reserves to speak of.

Germany, being the industrial powerhouse of the European continent, and home to the chemical factories of BASF, the car assembly factories of BMW and Volkswagen, and countless other precision industries, runs on an energy supply that it does not itself produce. This means that, if the price rises to a level of $200, these industries will not struggle to stay afloat and will no longer be competitive. The rumors of a deindustrialization of Germany, until now merely rumors, have become a statistical reality. A decrease in Germany’s GDP of 2-4 percent becomes entirely possible, and Germany finds itself squarely in the midst of a recession.

The ECB finds itself in an unfortunate position, being forced to choose between an inflation rate that is screaming for higher interest rates and an economy that is crumbling and crying out for relief. The probable outcome, however, will be one of inaction, with interest rates staying where they are, and the ECB in Frankfurt holding its breath and hoping for the best. The euro will also lose value in comparison to the dollar.

Britain will also contribute its share of risks to the equation. The British pound has historically weakened in comparison to other currencies under international pressure, and thus, the Bank of England will be in the same position as the ECB. For millions of Brits stuck in variable-rate mortgages and paying record gas prices, it will be an oil shock.

How Beijing Wins While the World Burns

China meets about 70% of its oil requirements through imports, amounting to 10-11 million barrels every single day. At $200 per barrel, the country’s oil bill jumps by $400-500 billion. That’s a huge blow to a trade balance already under pressure, and the economy is already struggling with a slow-motion housing bubble bursting. The yuan finds itself in a painful tug of war.

Beijing wants to weaken it to save export industries, but each time it does so, it has to pay more for oil. The People’s Bank of China finds itself in a dilemma from which there is no escape. Beijing will fall back on its tried and tested solution: cutting fuel costs for key industries, allowing the yuan to depreciate, and redoubling its efforts in transitioning to electric vehicles and solar power.

A geopolitical element adds another layer. If war in the Middle East disrupts oil supplies to the West, China will have tremendous bargaining power to cement its energy relationship with Russia, buying oil at ever deeper discounts. What appears to be a disaster for most of the world will be a golden opportunity for Beijing to get cheap oil from a desperate supplier.

Yen Trap: How $200 Oil Threatens the World’s Largest Debt Market

Among all countries, Japan finds itself at the extreme end of the scale when it comes to energy vulnerability. The country has virtually no domestic oil supply, and following the Fukushima Daiichi nuclear accident, a great deal of its nuclear power was shut down. The oil price rise will affect Japan on both sides, with a rise in oil prices and a weakening yen, since every rise in oil prices will mean Tokyo will be forced to burn through more dollars, thus weakening its currency.

For decades, the Bank of Japan has kept interest rates at zero percent or below, initially to fight deflation, and then just because they have. However, an oil-driven rise in inflation will require them to act, and a meaningful rise in interest rates will threaten to destabilize the Japanese government bond market, which is the largest sovereign debt market in the world. This is a systemic threat of global proportions. The Ministry of Finance will be forced to intervene in currency markets, selling down its reserves to prevent a further decline of the yen against the dollar.

The impact of an oil-driven rise in inflation on Japanese corporations such as Toyota, Honda, and Sony will be a mixed bag. They will be hurt on one side, but on the other, they will be cushioned to some extent by a weakening yen, making their exports cheaper to foreign buyers. They will survive, but Japanese people will be hurt, paying more for everything they consume. This might actually prove to be a blessing in disguise for the Japanese stock market, which will perform better than those in Europe even as the country’s economy struggles.

Australia’s Commodity Shield and New Zealand’s Open Flank

Australia has a unique position in that it is a major exporter of gas, coal, and metals, yet it imports most of its oil. It does not suffer from the effects of the oil shock in full measure, nor does it benefit from the oil shock in full measure. The increase in crude oil prices benefits gas producers such as Woodside Petroleum Ltd. and Santos Ltd. The increase in metal prices, due to inflationary pressures and increased military expenditure in most countries of the world, ensures that the mining giants remain profitable and continue to employ large numbers of people.

The Australian dollar is a natural hedge against oil price rises. Since it is a commodity-based currency, it tends to appreciate in value in response to rises in raw materials. So, the Reserve Bank of Australia will have the uncomfortable task of maintaining interest rates at high levels for much longer than it would have anticipated.

New Zealand’s economy will have a far tougher time. The New Zealand economy is smaller, and its export base is more limited, making oil imports more difficult to hedge. There will be no mining boom to offset the impact of oil price increases. There will be no gas export boom to boost the budget. The Reserve Bank of New Zealand, one of the most aggressive central banks in the world in responding to economic events, will be forced to keep interest rates steady or raise them. The New Zealand dollar will be under sustained selling pressure.

Financial Markets in the Blast Zone

Currencies

The EUR/USD pair will be the most affected. Recall the gas crisis in Europe in 2022? During that time, the euro was trading for less than the dollar. Now, a similar situation can arise in the market, and the euro can trade for less than the dollar.

Stock Indices, Bonds

Metals

Oil

Advice for traders: Cash is king in dollars; gold is its crown. Stay away from airlines and auto manufacturers. Focus on oil producers outside of the war zone – US, Brazil, Guyana – and defense stocks. Exxon Mobil (XOM) and Chevron (CVX) will continue to print money as the rest of the world burns.

Three Principles Retail Traders Should Follow

• Slow down. The most expensive mistakes in any crisis come when emotion rather than analysis is in charge. The temptation to act immediately, to sell everything or buy into what looks like a sure thing, is what separates those who survive a crisis from those who get sucked into its vortex.
• Diversification is rewarded in situations like these. Gold and short-term US treasuries have historically gone up when stocks go down. Oil producers go up when Europe goes down. A diversified portfolio may not avoid all losses, but it certainly takes the hit without falling apart.
• Diplomats are more important than price charts in situations like these. Geopolitical oil shocks have a pattern: they come on strong and can go away just as fast. A surprise ceasefire, a breakthrough in negotiations, a reopened strait – and oil is down $40-50 in a week. Traders who went all-in on oil stocks when fear is at a fever pitch may find themselves holding some of the most expensive stocks in the world as oil heads in the opposite direction.