The quarantines and shutdown of economic life precipitated by the Covid-19 pandemic has devastated the global oil industry. This is due to demand destruction occurring in the wake of panic responses to the coronavirus outbreak. Since the beginning of the year, oil prices have plunged from one half to around two thirds from their peak. On March 27, West Texas intermediate fell nearly 5 % from the previous day, to $21.51 per barrel, while Brent Crude was priced at $27.95. Lower grades of crude have plummeted to below $20.00 per barrel.

The collapse in oil prices has accelerated a price war between Saudi Arabia and Russia for market share amid declining demand, further exacerbating downward price pressures.

A global economic crisis that seems increasingly likely to become another great depression spells doom for the oil industry. However, there is one wild card; a war breaking out between Iran and the United States, which economist Nouriel Roubini sees as a high-probability event. This would create a supply shock to complement the demand shock to the global economy that has already occurred, reversing the decline in oil prices and sending them to record highs, at least temporarily before plummeting again. This would unleash a wave of inflation, leading to stagflation: negative growth combined with high inflation. That in turn would further depress economic activity, and impede a recovery in the global economy even after an effective Covid-19 vaccine has become widely available.

The International Monetary Fund (IMF) has just released a report warning  that economic growth worldwide is so fragile, policymakers in the top 20 economies, the so-called G20, must immediately prepare contingency plans. With repeated downgrading of its global growth forecasts, and further lowering of its projections likely, the IMF is in effect warning that the world stands on the precipice of a new global recession. It is urging policymakers in major sovereigns to prepare for future fiscal pump priming as a last measure to prevent further demand destruction.

Not surprisingly, the IMF report identifies two primary drivers of the underlying fragility of the global economy: China’s  slowing economic growth combined with turmoil in her equity markets and the collapse of the benchmark price of oil, inflicting massive fiscal turmoil on the world’s leading petroleum exporting nations. These factors have decimated global commodities and equities and have sown panic in financial markets across the globe.

Is this a repeat of the period just before the onset of the global economic and financial crisis of 2008, or perhaps something different, and even more ominous? Time will tell.

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The implosion of global oil prices that dominated the last quarter of 2014 will likely set the stage for the major economic news of 2015; the economic destruction wrought by the collapse of petro-economies. With the price per barrel of oil now south of fifty dollars, the stage is set for global economic volatility.

The vast level of price destruction being witnessed globally is only good news in the very short term; lower consumer prices at the pump, and a reduction of fuel expenses for major importers and industrial users of petroleum-based fuels, such as airlines. These short-term benefits will likely be overwhelmed by the fiscal consequences enabled by the implosion of oil prices  that will be faced by economies largely dependent  on oil export income to maintain their balance sheets.

Iran, Nigeria, Venezuela and Russia are among these economies most vulnerable to the collapse in oil prices. Currently, Nicolas Maduro, President of Venezuela, is hopping the globe in a desperate attempt to save his regime from defaulting on its sovereign debt. Countries facing fiscal disaster owing to the collapse of their major source of export income may resort to desperate measures, which may in turn create collateral ripples that afflict unforeseen damage on the global economy.

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A perfect storm has ravaged Russia’s national economy. With the price of oil imploding, the impact of its decline is inflicting devastating pain on the Russian economy. Fiscally , oil and natural gas revenues account for half of the state budget. The fall in oil prices is compounded by economic sanctions imposed by the European Union and the United States and Canada in response to President Putin’s aggressive polices vis a vis Ukraine.

There is nothing Putin can do about oil prices, especially with stagnant global demand and rising domestic production in the United States due to advances in shale extraction technology. However, he could mitigate the economic crisis through a more restrained policy on Ukraine. I doubt that will happen; it appears that in Russia, as with many other countries, nationalism trumps rational economic considerations.

It appears that bleak times are ahead for Moscow, and Russia’s nascent middle class. Just in the past 24 hours, the ruble dropped in value another five percent, all this in the wake of its earlier freefall when oil prices began to plummet. The erratic actions by Russia’s central bank only point to the inability by Russia’s rulers to arrest what will likely be a long-term period of economic recession and stagnation.

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Since mid-June the price per barrel of petroleum has collapsed by a staggering 37 percent. This almost perfectly  mirrors–in reverse- -the steep rise in oil prices  in mid-2008, which was followed by an equally sharp contraction when the Great Recession–the onset of the global economic and financial crisis–struck with full fury.

Only a few years ago, the talk in global investment circles was about the phenomenon of Peak Oil.  However, several factors have converged to precipitate the collapse of oil prices. Not only has the continued slump in the Eurozone  softened global demand for petroleum exports; the production of shale-derived oil in the United States, enabled by cost-effective technological breakthroughs in extraction, has greatly increased the global supply of oil, while dampening demand in the U.S. for oil imports. Furthermore, China’s growing appetite for imported oil has been at least partially retarded by lower rates of economic growth. In addition, OPEC has failed to cut global production, thus maintaining high global output of oil.

Oil remains a volatile commodity. A new crisis in the Middle East, particularly with Iran, could easily spike oil prices. However, if the economic forces that have propelled the downward  pressure on petroleum prices prove stable, the result could very well be fiscal calamity for several oil-dependent economies, particularly those of Venezuela and Iran, and to a slightly lesser degree Russia. Left uncertain is the long-term impact of shale oil extraction in the United States, which requires prices above the cost of extraction, currently in the mid-forty dollars per barrel range, to remain economically viable. With the current per barrel price of oil below 70 dollars, it is not inconceivable that further declines may place the booming shale oil industry in the U.S. in a serious quandary.

The current collapse of oil prices, combined with other negative economic trends, opens up long-term implications that will further upset the already fragile state of the global economy. The short-term befits of lower prices at the gas pump will be likely offset by the worldwide ramifications of shrinking fiscal resources for major oil-exporting emerging economies, which may place financial institutions and investment firms at risk that are highly exposed to debt by sovereigns that are highly reliant on oil exports.

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The latest news from Iraq clearly has geopolitical implications. No less important are the economic ramifications.  The Iraq war, which began with the U.S. invasion in 2003, is entering a new phase, and perhaps far more dangerous territory.

A Salafist-Islamist  insurgent group which goes by the acronym in English of ISIS (and by other acronyms and names as well), said to be to the right of Al-Qaeda (if that is even possible), has seized Iraq’s second largest city, Mosul, with a population of approximately two million. ISIS has seized others towns and strategic locations, while boasting of a march on Baghdad. The Iraqi army appears to be crumbling.

Amid talk of the United States getting back into the Iraq war, or Iran intervening directly with its own military forces , the price of oil has begun to spike. Normally, any military conflict, especially in the Persian Gulf region, will elevate the per barrel price of oil. However, another factor is at play. Just as Iraq was approaching the pre-2003 level of petroleum extraction, the internecine conflict’s escalation into outright civil war threatens to torpedo any meaningful exports of Iraq’s crude oil in the future.

A disruption in the supply of Iraq’s oil on the world market could create a cascading effect on oil prices, already at $110 per barrel and climbing. It should be remembered that in the summer of 2008 oil’s climb to a price north of $140 per barrel was a key element in the unleashing of the global economic crisis, from which a feeble recovery is still underway. The global economy is  fragile and vulnerable to another oil shock.

Among all the calculations being weighed in Washington, Tehran  and elsewhere, policymakers must understand that the growing signs of disintegration of the unified Iraqi state, among other crises in the Middle East, may foreshadow a repetition of the oil price crisis of 2008. The unraveling of the American-installed Iraqi political structure may be a harbinger to a return to oil scarcity and elevated oil prices, with all the attendant negative effects on the global economy.

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Now, however, the price of oil is once again moving upward. In part, suggest analysts, this is due to a perception that the worst of the economic free fall is behind us. Whether those perceptions are valid or not (and I don’t believe they are), psychology is an important factor is establishing commodity valuation. However, I believe there are other forces at work, or which may intervene in the future, that could radically escalate the price of hydro-carbon energy irrespective of recessionary constraints on consumption. Here, briefly, are factors to consider in anticipating any future oil shock:

1. China hedging on oil. Apparently, the Chinese are shifting investments allocated from their sovereign wealth fund from U.S. Treasury bills to commodities, including oil. With a sharp drop in exports only partially redressed by a stimulus-funded drive at boosting domestic consumption, it appears that China is building up an oil reserve in anticipation that this commodity will eventually rise greatly in price, simultaneously with the future depreciation of the American dollar. Should China’s oil hoarding increase in tempo, a significant upside in the price of petroleum will become highly probable.
2. Political instability in the Persian Gulf. The political upheaval occurring in Iran in the aftermath of a presidential election widely perceived by the Iranian people to have been rigged has an unpredictable dynamic. However, most scenarios, either involving prolonged violence or the perpetuation of a radical regime committed to acquiring nuclear weapons, will likely facilitate events that will impact the supply of oil from the most energy-intensive real estate on the planet. Even the mere perception that things might go bad will be enough to drive up the price of oil. Actual events, including internal and external violence, will impose a significantly higher cost penalty.
3. A terrorist attack involving a strategic target related to the oil industry. Al-Qaeda is well aware of the vulnerability of the global economy, at a time of profound financial and economic crisis, to a targeted attack on a vital element related to the oil industry. Only one single but highly significant target would be enough to send the price of oil to a much higher level. Unfortunately, Al-Qaeda and its allies have many choices to select from a menu of targets. In terms of extraction, transportation to consumers as well as refining and storage infrastructure, there are literally thousands of targets across the globe, any one of which would prove impactful to the stability of oil prices. It would be unduly optimistic to assume that Al-Qaeda is not focussed on such an objective, or that security forces are so effective that they can protect every possible target.

The fall in oil prices from their record highs of last summer amounts to, in effect, a tangible economic stimulus program. Unlike government stimulus spending programs, the fall in oil prices required no deficits, and meant an immediate infusion of money into the pockets of private and corporate consumers. Conversely, the return to higher energy prices at a time in which the world is experiencing its worst economic crisis since the Great Depression of the 1930s would, in terms of impact, be a major tax penalty being imposed on any attempt at a sustained recovery. In essence, the entire global economy is being held hostage to the volatile pricing forces of an essential commodity. Clearly, when it comes to oil price levels, the market does indeed rule.