Oil prices could be the next monster under the bed for the economy

The price of oil topped $105 per barrel, a level not seen in more than a year. The trigger appears to be supply data, which showed crude supplies dropping by double what analysts expected. A big driver of higher oil prices has been continued political tension in Egypt, which controls the Suez Canal, a key checkpoint for producers.

Barbara Kollmeyer
July 10, 2013, 10:30 AM
Market Watch

Oil prices are drawing attention on Wednesday and that wasn’t for nothing.

The price of West Texas Intermediate crude CLQ3 +2.00% topped $105 a barrel, a level not seen in more than a year, while London’s Brent crude UK:LCOQ3 +0.49% contract topped $108 a barrel, which hasn’t happened since earlier this year.

The trigger appears to be supply data, which showed crude supplies dropping by double what analysts expected. Price Futures Group analyst Phil Flynn summed it up:

“This is a big shock. While most were looking at another drawdown in supply, no one expected this drop.”

Oil also got a boost from a big China trade data miss, which some say could provoke some policy easing out of China, a country whose growth engine is already sputtering. Oil likes growth, and especially China growth. But the other big driver for oil has been continuing political tension in Egypt, which controls the Suez Canal — a key chokepoint for producers.

Wells Fargo advisors was among those voices warning investors not to chase gains as a positive outcome in Egypt could lead oil to pullback. But for now, plenty are not so sure oil will calm down and more concerned about what that means for the economy. One big worry is that higher oil prices will cause pain at the pumps, largely for Americans, though Europeans will also be feeling pinched (some say China and India are already at a pain threshold), and they are already in a rut of an economic situation (just ask the IMF). Keith McCullough, chief executive officer at Hedgeye Risk Management was flagging it to clients on Wednesday:

“Oil is testing a breakout above our long-term tail-risk line of $108.36/barrel this morning. Our global macro model says that oil price (or higher) is where we choke global consumption demand. Since U.S. consumption growth effectively doubled in the last 6 months to 2.4% vs. 1-1.2% prior, that’s a headwind, on the margin.”

consumption Here’s McCullough’s chart that clearly shows the upward path that spending has been tracking.

Stephen Guilfoyle, chief economist at sarge986.com, says he’s “already uncomfortable” in the $105 area for crude. If the market gets another downside surprise via the EIA report due later this morning, could startle the market again.

“Right now, Egyptian headlines will rule momentum. Combine a weak inventory print with something threatening supply lines in the Middle East and it will be really difficult to put a technical number on it, because the reaction would be emotional,” says Guilfoyle.

Some say, though, that the economy can take a higher pain threshold on oil.

“Right here in the U.S., it’s not having much of an impact in terms of gasoline prices just yet, but if the trend continues to say $115 or $120, and I’m not suggesting it will get there, but that will be a negative. That will mean much higher prices at the pump and obviously would weigh on disposable incomes,” says Peter Cardillo, chief market economist at Rockwell Global Capital. And oil at $125? Really bad, he says, and there’s no way the Fed will ignore it.

Here’s how it felt when oil climbed up to $108 in March 2012 and Brent jumped to $125.

Now for the silver lining, if there is any — oil stocks. Russ Koesterich, chief investment strategist for BlackRock was also flagging to his clients over the weekend that oil needed watching. He said that rising political tensions are likely to keep oil prices moving higher, and says investors should take advantage of that by investing in large-cap global energy companies. Oil stocks weren’t exactly busting out on Wednesday, at least in Europe, with BP BP +1.12% UK:BP +1.04% up about 0.7% in London.

Scott Redler, chief strategist for T3Live.com, was telling his clients on Wednesday that the fresh moves by oil may put these names back in play: Baker Hughes BHI +0.23% , Schlumberger SLB -0.37% , Halliburton ha HAL +0.16% , ENSCO ESV +0.19% , Exxon Mobil XOM -0.66% and Chevron CVX +0.14% .

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