How to know when oil prices will cause a recession, what to invest in

With the national average for a gallon of gas hitting its highest price since 2008 and the stock market on edge with the first land war in Europe since WWII being waged by one of the world’s biggest crude oil producers, crude oil prices and energy stocks are an area of focus for investors. It is hard for stock market participants to avoid the question, are energy stocks, which have had a huge run since the pandemic bottom, still a buy given the geopolitical premium? But the related question could stop them in their tracks before continuing: will oil prices cause a recession?

Bespoke noted last week that as of Friday morning, WTI crude oil was up just over 20% within the week, one of five periods where crude rallied more than 20% in a week. It noted that three of the prior four periods where prices spiked occurred during recessions.

Rystad Energy, one of the top global energy sector consulting and research firms, expects a plunge in Russian oil exports of as much as 1 million barrels per day — and limited Middle Eastern spare capacity to replace these supplies — to result in a net impact that oil prices are likely to continue to climb, potentially beyond $130 per barrel, and relief measures such as releases from the Strategic Petroleum Reserve can’t make up the difference.

There is of course disagreement and contrarian takes. Citi’s commodities team wrote last week it is becoming “probable” that oil prices have peaked already or could soon consolidate near a top. But that would require a de-escalation in the Russia invasion of Ukraine and progress on Iran talks. U.S. inventories are at or near lows, but Citi says stock builds are on the way in 2Q’22. 

For Nicholas Colas, co-founder of DataTrek Research, this is a good time to look at the value of energy stocks in a diversified portfolio and how to think about the risk of oil prices causing a recession.

As an analyst covering the auto sector earlier in his career, Colas remembers the presentation decks used by economists employed by the “Big Three” automakers three decades ago, which they had been using since the 1970s oil shocks.

“The rule of thumb I learned from auto industry economics in the 1990s is that if oil prices go up 100% in a one-year period, expect a recession,” he says.

A year ago, crude oil was $63.81 (March 4, 2021) a barrel. Double that and that is the strike price for a recession. Crude oil is currently at $115.

“We are close and getting there fast,” Colas said.

“We’re at the point now where prices at the pump are higher on the way home from work than on the way in,” Bespoke wrote in a note to clients on Friday.

But Colas added oil prices would need to be persistently over that doubling, staying at $130 rather than merely spiking and pulling back quickly, to be concerned. “A day or two is OK, but a few weeks is not,” he said. 

A big caveat: the evidence isn’t…