Email

How the Latest Greek Drama Will Affect the Price of Oil

by | published June 30th, 2015

In Greek history, there is a story that after devising the Athenian system of governance the great classical lawgiver Solon was walking down from the sacred council site of the Areopagus when he was greeted by another citizen.

“Well, Solon, did you give Athens the best constitution possible?” the fellow asked.

“No,” Solon responded. “I gave her the best constitution she could accept.”

It seems politics in the cradle of democracy haven’t changed much in the last 2,500 years.

Take the current (and soon to be former) Greek Prime Minister Alexis Tsipras as a good case in point.

His Syriza party currently “anchors” the government in Athens. Essentially a coalition of the far left in the Greek political spectrum, it rode into power on a wave of popular anger over debt and creditors.

This populist government has now broken off negotiations with creditors. Greece will certainly miss its interest payment to the International Monetary Fund (IMF) due today and will not be able to make the larger payments to the European Central Bank (ECB) scheduled over the next month.

Here’s my take on how this Greek drama will play out… and affect the energy markets…

Tsipras Will Leave an Unusual Legacy

Some of this anger was understandable and not particularly unexpected. The Greek people have had a miserable go of it over the past several years as austerity budgets, rising unemployment, the lack of any coherent fiscal and monetary policies, and declining genuine investment expectations cast a pall on the country.

I saw some of this a while back when I was in Athens to talk about the relationship between debt and oil prices (more on that in a moment). There was a roughness forming in the streets while the graffiti adorning public buildings was becoming confrontational.

Tsipras played to all of this by running a populist campaign.

Unfortunately, in the five months he has been in office, his cabinet has done nothing. A left-wing farce all dressed up like a government has managed to fragment its own political base, develop no policy, negotiate in bad faith (when they weren’t simply walking away from the table altogether), and put a country on the brink of an economic disaster, along with an exit from the euro zone and perhaps the EU itself.

In response to all of this, Tsipras blamed outside creditors (one populist ploy) and decided to let the people decide the matter in a referendum to be held on Sunday (another game of populist chicken).

As the final nail on the coffin, banks and the stock market are closed, along with the introduction of severe capital controls limiting withdrawals while making normal cross-border business almost impossible.

Even if he wanted to compromise at this late point, Tsipras can’t. He has painted himself into an inescapable political corner.

Indications are that over 60% of the Greek population want to remain in the EU and the euro zone. If that holds up in Sunday’s vote, Mr. Tsipras will resign, leaving as his legacy for five tumultuous months something unusual for a politician of any persuasion:

Absolutely nothing.

The Impact on Oil Prices

This mess should never have made it this far.

It will have an impact on oil prices, more pronounced the longer the situation remains unresolved. There are three primary concerns, all of which are pushing oil lower. Once any sort of resolution emerges, oil prices will bounce back. But the longer that takes, the more volatility will increase.

First, as the euro declines against the dollar – a certainty as the Greek economy unravels – it will be more expensive for Europe to buy oil. That trade is denominated in U.S. dollars. A declining euro, therefore, increases the cost of oil, effectively lowering demand. It is the lowering demand that will serve to push prices lower.

Second, European banking credit is in far better shape than it was the last time Greece threatened to implode. The ECB’s policy of quantitative easing, the buying of distressed bonds, and the level of bank reserves are major bulwarks against immediate contagion. Here other “weak sisters” in the EU southern tier become primary concerns – Italy, Spain, and Portugal. The amount of debt currently in question for Rome or Madrid dwarfs the ledgers at issue in Athens.

However, while the euro can be protected, a further rise in debt yields cannot. Put simply, this will add to the spread between investible bonds and high-yield (i.e., junk) paper. Energy company issuances occupy the highest levels of high-yield debt, requiring a premium paid over other bonds. This will increase the expense of conducting oil business and the cost of running futures contracts on the product. That will cut into return and lower the attractiveness of oil.

Finally, the broadest and most difficult result to calculate. The rising economic and financial uncertainty descending on a wider continent will factor into projections of economic recovery (or the lack of it). As these are adjusted downward, so also will broad indicators of crude oil demand. And that pushes down oil prices.

However, while the drama in Greece will lower the price of oil in the short term, the price will recover in the longer term as the situation is resolved.

I will follow these developments for you. Stay tuned for more.

Please Note: Kent cannot respond to your comments and questions directly. But he can address them in future alerts... so keep an eye on your inbox. If you have a question about your subscription, please email us directly at customerservice@oilandenergyinvestor.com

  1. Paul Ellenbogen
    June 30th, 2015 at 17:09 | #1

    Fail to c the connection. With the major producing countries pumping out as much as possible and the Iran overhang pending a nuclear deal and electric cars hard to make a case for higher oil price

  2. michael
    June 30th, 2015 at 17:16 | #2

    First one needs to understand Greeks – good luck I am an American Greek and when I go to visit I could never figure there political climate. As a populous they are irrational and a highly emotional bunch – just look at all the rallies that go on daily. That is because many have nothing to do – once they retire – in their late 40’s into mid-50s the sit around play cards and dominos and look for excitement. Once retired, many are not allowed to work or they loose their pension – idiotic since many are in their peak earning years. However, that mantra is obviously changing – creating a hyper unemployment rate.

    The Euro has made it confiscatory for the average Greek to make ends meet on a daily basis. So, they simply lean to the left in hopes of a bailout that is not likely coming. Which is worse leaving the EU and going back to the Drachma at a much reduce exchange rate for awhile and sucking it up or doing the same thing with a Euro that no one can afford. At least with a debased currency tourism would flourish – just go back to the 1970 – 1980s. And don’t forget that is a major business in Greece – just ask the Germans.

    This is a conundrum facing the Greeks – my bet the referendum will result in staying in the EU, but only for awhile. Eventually either Greece gets kicked-out or leave on their own volition – unless the EU forgives much of the current debt. Greeks are proud and hardy people to be sure – and will not stand for much more of the belt-tightening – that is why the left got in power.

    the EU does not understand – its about the people not politics – you don’t change a culture that has been ongoing for 40-years and expect a “rational” outcome.

  3. schippe1
    July 1st, 2015 at 04:11 | #3

    Greece is broke, and giving them more money won’t help. And they aren’t the only ones. Most the people living in the U.S. are one paycheck away from being broke.

  4. Mike Lipinski
    July 1st, 2015 at 19:02 | #4

    Greece is not the problem; the EU, the United States and the multinational corporations, are. When did asserting one’s independence through democratic means become dishonorable or somehow laughable? The issue here is that the Troika, led by Germany, who after being beaten in two world wars, is once again telling everyone what to do, is afraid that if Greece leaves, it’ll cause an avalanche of deserters. This would be an ideal solution. Greece will be fine. Funny how nobody talks about Iceland, which turned its economy around on its own steam after the financial debacle of 2008, no thanks to “banksters” and other multinational crooks.

  5. Rudran
    July 2nd, 2015 at 20:14 | #5

    Germany is trying to have it both ways; its currency DM would have risen significantly over past 10 years crippling exports; but the Euro was held back by the PIGS and Geman exports did very well with a competitive Euro. Now they want to punish Greece. I hope Greece bites the bullet and leaves Euro unless given substantial debt write offs and interest forgiveness.

  1. No trackbacks yet.