Every time an oil crisis occurs, the recession scenario is immediately dusted off. The oil price rises, analysts pull out their charts, and within a week the first warnings appear that a recession is inevitable. But the relationship between oil crises and recessions is much weaker than is commonly assumed.
That relationship largely consists of coincidences, and correlation should not be confused with causation. Moreover, the sensitivity of the global economy to oil has been steadily declining, due to the sharp drop in oil intensity and, of course, also because of the current oil crisis. Especially in this century, dependence on oil has decreased significantly in many countries.
First, let’s put the fuss about oil prices into perspective. Oil prices have lagged far behind inflation this century. Almost everything has gone up in price, except energy. Prices go up largely due to higher wages, but that also means a higher income, so people can still afford their beers and eggs. The idea that a higher gasoline price would suddenly be a problem, does not fit that picture.
The only recession actually caused by an oil crisis was the first one, in the early 1970s. All subsequent recessions had different causes. The deep recessions of the early 1980s were caused by Paul Volcker, the chairman of the US Federal Reserve who took office in 1979. Volcker sharply raised interest rates to deliberately trigger a recession and bring persistent inflation under control. That was monetary policy, not an oil crisis.
The first real recession after that was in 1990. Of course, it is tempting to link it to the rise in oil prices resulting from the first Gulf War, but the recession in the United States was primarily the result of the savings and loan crisis, which had nothing to do with oil. The recession after 2000 was also unrelated to oil, but instead to the bursting of the dot-com bubble. And the high oil price around 2008 was not the cause of the Global Financial Crisis, but rather a consequence of the spectacular demand for oil from China, which experienced unprecedented economic growth after joining the World Trade Organization in 2001.
The coincidence of recessions with high oil prices is therefore largely just that—coincidence. The real cause of a recession almost always lies in the economic boom with excesses that precedes it. Too much investment, excessive inventories, a labor market that overheats, and a Federal Reserve forced to raise rates amid the euphoria. The economy slows, and naturally the demand for oil declines as well. High oil prices are more a symptom than a cause.
The current oil crisis may very well be the last. The pattern is familiar: just as in the early 1970s, governments want to become less dependent on oil from the Middle East. That first oil crisis gave a boost to the search for oil outside the region. The Brent field in the North Sea was discovered in the early 1970s, and its development benefited from the tripling of oil prices at the time. Energy conservation also became the norm. Governments introduced subsidies for insulation and double glazing.
Today, there is an alternative to fossil fuels in the form of the energy transition. What was once dismissed as an extreme sacrifice for climate and the environment has become an economic necessity due to the problems surrounding the Strait of Hormuz. Europe wants to become less dependent on oil and gas. Liquefied natural gas from Qatar initially seemed like an alternative to Russian gas, but increasingly appears to be a case of jumping from the frying pan into the fire. Combined with the fact that the global economy is far less dependent on oil compared to half a century ago, it makes it unlikely that another (similar) oil crisis will follow in the future.
Anyone looking at economic indicators today—industrial production, purchasing managers’ indices, corporate profits—sees a picture that is difficult to reconcile with the recession narrative. Economic growth is stronger rather than weaker. The labor market remains tight, consumers continue to spend, and the investment cycle in AI and data centers is creating a structural boost in demand. This is not the backdrop of an impending recession. It is the backdrop of an economy that may be slowing from its peak, but is still far removed from contraction.
In addition, the environment for investors has actually become more attractive. Profits are rising faster than stock prices, which means valuations are declining rather than increasing. If oil prices fall, it is very likely that inflation will drop below the “two-percent-target” of central banks and that interest rates will also decline. That is the Goldilocks scenario in its most pronounced form: not too hot, not too cold, with falling oil prices as an added lubricant.
Moreover, the stock market is responding to the declining likelihood that Republicans will win the US elections in November, raising the prospect of Trump becoming a “lame duck” president. This implies tax cuts, deregulation, and unconventional trade policy in the form of more deals ahead of the elections, all aimed at pleasing voters (and investors). The outlook for investors is therefore more positive than at any point this century. The combination of falling oil prices, declining inflation, lower interest rates, rising profits, and a political climate that supports the market does not occur often. Party like it’s 1999.
Han Dieperink is chief investment officer at Auréus Vermogensbeheer. Earlier in his career, he was chief investment officer at Rabobank and Schretlen & Co.