From Falling U.S. Wealth to Indian Factory Closures, Oil Shock Raises Global Recession Risk

Global Recession Risk Grows Amid Oil Shock and Global Factory Closures

Escalating Economic Pressures from Oil Shock and Factory Closures

By Howard Schneider, Timothy Aeppel, Sarah McFarlane and Sumit Khanna

Impact on Businesses and Supply Chains

SAN FRANCISCO/AHMEDABAD, India, April 7 (Reuters) - Kevin Kelly is in a tough spot. What he says are unprecedented price increases in the weeks since the United States waged war on Iran mean the Californian, who makes plastic bags for groceries, may have to break contracts he cannot afford to honor with his customers.

Thousands of miles away in India, gas shortages have closed dozens of plants that export aluminum products around the world. And in Britain, some farmers are eking out their fertilizer stocks as prices soar.

With the war in its sixth week and almost a fifth of the world’s oil supplies affected by Iran’s limits on shipping through the Strait of Hormuz, consequences are spreading from financial markets into business activity, raising risks of a global economic pullback – or even recession.

Case Study: Emerald Packaging's Struggles

Kelly said sharp jumps in the cost of plastic resin over a couple of weeks from 45 cents to 85 cents per pound meant it would be economic suicide for Emerald Packaging, his $92 million a year family-owned business, to keep the prices agreed in pending orders.

"We'll just declare force majeure," he said during an interview at his Union City factory near San Francisco.

When a company declares force majeure, it is telling customers it cannot deliver on contracts due to factors beyond the company's control.

"The increases are so high, if we were to lose a customer because we pass them through, we just have to let them go," he said, adding that he expected most of his long-standing clients would understand and swallow the changed terms.

Wider Economic Indicators and Risks

Countries in Asia and Europe are more exposed to the fallout of the Gulf energy shock than the United States. However, analysts say pullback among American consumers is inevitable as inflationary pressures rise. In a sign that the problems faced by Emerald Packaging are more widespread, prices paid by businesses for inputs increased by the most in more than 13 years in March. Goldman Sachs has raised its view on the risk of a U.S. recession to as much 30%.

U.S. President Donald Trump has kept investors on edge by talking up negotiations with Iran while threatening to destroy its civilization and send it back to the Stone Age with intensified attacks, including on its bridges and power plants. He warned Iran could be "taken out" if it did not meet a Tuesday night deadline to reach a deal.

Benchmark Brent crude cost about $109 a barrel on Tuesday, and has remained above or around $100 for more than three weeks, up over 50% from about $70 just before the conflict began on February 28.

Expert Opinions on Oil Price Thresholds

Risks sharpen for the global economy if oil moves above $110 or $120 a barrel, warned Nathan Sheets, chief global economist at Citi and a former U.S. Treasury Department official.

"As this shock gets bigger and bigger, the risks of recession are rising significantly...There are likely some thresholds where...certain kinds of economic activity no longer are justifiable, and you have a sharper, more nonlinear pullback," Sheets said.

The war, if it persists or escalates, is likely to test the trigger price at which the world's demand for petroleum is wrenched into line with its suddenly constrained supply. That means a contraction in economic activity.

If the current disruption to supply is sustained, 13 analysts polled by Reuters forecast an oil price of between $100-$190 per barrel for the year.

Attacks that have severely damaged refineries, ports and oil storage in the Gulf region mean energy supplies could take months to return to previous levels even if combat ends, meaning a sustained period of higher prices, according to state-run oil and gas companies in Kuwait and Qatar.

Even if the conflict is swiftly resolved, the International Monetary Fund is set to reduce its forecast for global economic growth and bump up its outlook for inflation, IMF managing director Kristalina Georgieva told Reuters on Monday.

Roughly 20 million barrels of oil and refined products had shipped out of the region each day before the war. Only a fraction of that is now reaching global markets through alternative pipeline routes.

"A disruption of this size is going to require significant demand destruction in order to balance the market,' said Travis Flint, an investment grade credit analyst with Columbia Threadneedle, referring to declines in consumer and business demand that typically follow sustained high price. He compared the situation to the COVID-19 pandemic. 

Uneven Economic Pain Across Regions

UNEVEN ECONOMIC PAIN

Whatever the scenario, the impact won't be spread equally.

United Kingdom: Growth Downgrade and Farming Challenges

In the energy import-dependent United Kingdom, the Organisation for Economic Cooperation and ​Development cut its forecast for British economic growth this year to 0.7% from a previous forecast of 1.2%, the ​biggest downgrade of any major economy.

For cut-flower farmer Matthew Naylor in England's East Midlands, rising fertilizer costs and limited supply mean tending his fields with stocks he has on hand. He had heard talk, he said, of other farmers assessing whether more money was to be made selling their fertilizer than growing crops.

"The best thing we can do is to be very, very economical with what we have and just to hope that sense prevails internationally," he said.

Asia: Factory Closures and Export Impacts

In parts of Asia, the shock is hitting hard.

In India’s Gujarat, many aluminum extrusion plants shuttered "four to five days after the war started due to unavailability of gas," said Jitendra Chopra, president of the Aluminium Extrusion Manufacturers Association of India.

India is a leading world exporter of the metal product used in construction, solar panel frames, transportation equipment and consumer goods, and its problems could over time lead to higher global prices.

Geopolitical Tensions and Economic Relations

China and US Relations

CHINA AND US RELAT