How the Latest Greek Drama Will Affect the Price of Oil

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.

The post How the Latest Greek Drama Will Affect the Price of Oil appeared first on Oil & Energy Investor | Dr. Kent Moors.

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