Oil Between $50-$75 Is A Good Thing

As WTI Crude oil for July delivery passed $65 a barrel last week there was talk that high oil prices could derail the recovery. We share this view with one qualifier; oil prices above $50 take significant political risk off the table.

Most of the Gulf States have based their previous budgets on oil above $50 a barrel. When oil dipped below this level, many countries, including Iran were forced to cut expenditures. The fastest way to derail economic recovery would be to have political and social unrest in Iran.

Our neighbor to the south, Mexico, has also been labeled a dangerous state with the potential for rapid collapse. The Mexican government has been fighting a losing battle with drug cartels. The government relies on oil sales to fund over 30% of the budget. In what was probably the greatest trade by a country in 2008, Mexico hedged its oil output at $70 a barrel through Goldman Sachs (GS). This allowed the government to continue to fund the war against the drug dealers. As oil approaches that level again, we would advise President Calderon to pay a visit to his friendly bankers at Goldman Sachs. And since the US government is so keen on intervention, we should encourage this meeting in the name of national security. Despite the light sarcasm of our suggestion, social unrest is a serious threat and is a direct result of not enough money.

Additionally, oil at the higher end of the range ($75) makes exploration and alternative energy a profitable venture. Certainly, higher gas prices will crimp consumer spending and is why we see oil above $75 a barrel as detrimental to the economic recovery. There is a delicate balance between stability and recovery.

Disclosure: I am long UGA.

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