Southern Limits

The global economy is based on transportation networks that are propped up by cheap energy. Because of this we can be relatively certain that when demand for energy begins to fall that the economy is slowing. And when energy prices fall sharply we can be relatively certain that the economy is not just slowing but entering into a recession.

Jeff Rubin, the former Chief Economist for CIBC World Markets has showed convincingly how global recessions are linked to high oil prices. Rubin had this to say back in May 2011:

There will be many dress rehearsals in commodity markets before the next global recession. An example is last week’s dramatic and broad-based selloff that took oil prices for over a $10/barrel tumble. And there is no doubt that despite the scarcity of the resource, the price of oil will crash the next time the global economy sewers.

What we are seeing right now is the price of oil crashing. Brent crude futures for July delivery dipped below US$100 per barrel. Prices are on track for the biggest monthly loss since 2010. Brent crude prices have plummeted by over 25 percent from a high of US$126.40 in March 2012.

First quarter GDP growth forecasts for the U.S. dropped almost 16 percent from 2.2 percent to 1.9 percent. The Standard and Poor’s 500 index was poised for its worst monthly drop since last September. Bill Clinton believes the U.S. is already in a recession.

India’s GDP growth has slumped to a nine year low of 5.3 percent. China is slowing down too with the World Bank dropping growth forecasts by 2.4 percent from 8.4 percent to 8.2 percent.

The situation in Europe is even worse with Greece highly likely to default on loan repayments and leave the monetary union before the end of the year. If Greece goes it is quite possible that Portugal, Italy and Spain will not be far behind. This will wreck havoc on those countries left in the union as the Euro begins to rise again. This will squeeze exports, especially in Germany which has remained relatively unscathed by the Euro problems so far. The United Kingdom is officially in recession and the Bank of England has cut interest rates to a 300 year low.    

In economic terms the sky is falling. We are likely to see the price of oil continue to fall but probably not as low as in 2008. This is due in part to the huge increase in production from unconventional oil plays over this period. The baseline cost of oil today is more expensive than even five years ago.  The Canadian tar sands and many of the tight oil fracking operations become unprofitable under $40 per barrel and so we will likely see a number of oil and gas projects cancelled or deferred just like in 2008.

No matter how deeply tinted your rose glasses are the world economy does not look good right now and almost every indicator points to it getting much worse. Brace yourself.