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Rising oil prices could push world into a recession; no economy can expand without energy - Bank of America

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(Kitco News) - The oil market continues its relentless climb higher, pushing to within a hair's breadth of $120 a barrel Tuesday. The energy market continues to be dominated by supply chain issues due to Russia's ongoing invasion of Ukraine.

Because of the conflict, European leaders announced further sanctions on Russia, saying it would reduce Russia's oil imports by 90% by the end of the year.

Many economists have warned that rising energy prices, pushing inflation pressures to unprecedented levels, raises the threat of a recession. In a report Friday, Francisco Blanch, head of global commodities and derivatives research at Bank of America Securities, has added his voice to the conversation, saying there is a growing risk of a 1980s commodity-induced recession as oil prices hit move to new record highs.

"Can the global economy continue to expand with tightening oil supplies? Our estimates suggest that the world can handle a total disruption of just about 2mn b/d of Russian oil without risking a global recession," he said in his latest market report.

Before the invasion, Blanch noted that Russia exported about 8 million barrels of oil per day.

"For next year, we believe oil demand could approach pre-Covid levels but only if Russian liquids production holds near 10mn b/d and OPEC+ supplies increase. With our $120/bbl Brent target now insight, we believe that a sharp contraction in Russian oil exports could trigger a full-blown 1980s style oil crisis and push Brent well past $150/bbl," he said.

Although global GDP has a lower correlation to the oil market than compared to 40 years ago, Blanch said that the global economy continues to rely on energy to expand.

"We have historically measured our GDP by looking at things like the number of cars sold, the number of air trips people made, or the number of new data centers we created in a given year," Blanch said. "No major economy can expand without energy. Whether the source of this energy is thermal or renewable matters less, in our view, as long as it is available."

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Although Russia's war with Ukraine has exacerbated issues in the energy market, Blanch noted that supply had been an issue for a while, which could lead to stickier higher prices.

"At the heart of the supply problem in the oil market is the change in the oil price elasticities of supply. Collectively, the non-OPEC rig count has failed to react as it did in the past to rising global oil prices," Blanch said. "The net result is that prices now have to work twice as hard to balance the market in the face of a negative supply shock."

Bank of America also sees a stronger U.S. dollar impacting the oil market. Blanch said that the recent breakdown in the relationship between oil and the U.S. dollar has been astonishing.

"Historically, a strong USD would mean lower oil prices and a weak USD would translate into higher oil prices. The flip from the world's largest energy importer to a net exporter is, in our view, the main culprit of this shift. As a result, coupled with rising crack spreads, most major economies are now facing much higher diesel prices in local currency than in June 2014," he said.

Although recession risks are elevated because of rising energy prices, Blanch said this scenario is still not his base case. He added that consumer demand remains robust and healthy, supporting economic growth.

"The U.S. is unlikely to fall into recession because of high energy prices, but other countries are facing a much more taxing energy problem.

Along with rising energy prices, commodity analysts see the potential for gold prices to rise. Higher energy prices will continue to drive inflation higher and the threat of lower growth would create a stagflationary environment.

Bank of America is not the only major bank to wade into the recession debate. In a note Tuesday, Goldman Sachs Chief Economist Jan Hatzius said that they don't see the U.S. economy falling into a recession.

"While our growth forecast has long been below consensus, we believe fears of declining economic activity this year will prove overblown unless new negative shocks materialize," he said.

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