The threat to Europe from rising oil prices

Higher oil prices are bad for everyone. But Europe is particularly vulnerable. John Stepek explains why, and what you can do to protect your wealth.

The oil price surged again yesterday.

This time, it was because of rumours of an oil pipeline blast in Saudi Arabia.

Saudi denied this outright. A spokesman for the industry told the Financial Times that there had been "no incident whatsoever".

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He hinted that the report was a hoax put out by Iran. The country is irritated at Saudi boosting oil production to offset the impact of US and European sanctions.

But the fact that a mere rumour can trigger a surge like that sending oil to its highest level since 2008 shows just how jittery the market is.

High oil prices are bad news for everyone. But which economies would suffer the most?

Europe is more vulnerable than the US to rising oil prices

As my colleague Matthew Partridge recently pointed out, the oil price doesn't have quite the same capacity to shock as it did back in the 1970s. Our societies are generally more fuel efficient for one thing.

But that's cold comfort when you're standing at the petrol pump, wondering whether the fuel efficiency you gain by only half-filling your tank will be offset by even higher prices the next time you go to fill up.

Consumers the world over are united in complaining about high petrol prices. The complaints of the Americans may sound hollow to us Brits, given that they pay roughly half of what we pay at the pump. They are yelping with pain at the idea that petrol could cost $5 a gallon by the summer. In Britain, as the International Business Times points out, prices already average nearly $9 a gallon.

But when you're used to prices being at any given level, it hurts when they start to surge. And because US gasoline' isn't taxed as highly as in Britain, their pump prices are more sensitive to changes in the price of crude.

Yet Capital Economics reckons that Europe remains more vulnerable to a surge in oil prices than the US. Why? There are two main reasons. For one thing, the European economy is already fragile. Secondly, Europe doesn't have the shale gas reserves that the US has.

Shale gas America's secret weapon

This is where America's really big advantage comes in to play. Natural gas in the US is dirt cheap, driven lower by the glut of gas released from shale by new technology. That means that what US consumers lose at the petrol pump, they've gained in their heating bills. Europe, on the other hand, has had no such offsetting benefit.

This US gas glut may have a knock-on impact that will make things even tougher for Europe (and the UK for that matter). As James Ferguson notes in this week's issue of MoneyWeek magazine (out today - if you're not already a subscriber, you can subscribe to MoneyWeek magazine), surging domestic gas production means the US may have to import less oil. That will shrink the US trade deficit. That in turn, will tend to make the dollar stronger.

If the dollar strengthens, the cost of oil in pounds and euros will rise even further. It's already at record levels in both currencies. And even though higher oil prices are recessionary (they cut into spending power, so hurt demand), they also push inflation up. This makes it harder for central banks to justify loose monetary policy.

That might not matter to the Bank of England, which has pretty much given up on its inflation target. But it'll matter increasingly to the Germans. With the European Central Bank (ECB) trying to make monetary policy more appropriate for the weaker members of the eurozone, policy is already far too slack for Germany.

While most banks in Europe are cracking down on lending, the FT reports that German banks are "eager to provide finance". Funds that once went to fast-growing countries on the periphery, are now deserting them for the safety' of solid, export-led Germany. "Banks need to put money to work and Germany looks safe at this point in time", Michael Dawson-Kropf of rating agency Fitch tells the FT.

Indeed, one fund manager I was speaking to recently thought it wasn't beyond the realms of possibility that Germany could see a house price bubble start to form. Prices rose by 5.5% in 2011, which is a real jump by German standards. We'll be revisiting this story in a future issue of MoneyWeek.

But the point is, if surging oil drives prices higher, at the same time as Germany is developing an Anglo-Saxon-style credit boom, there'll be even more pressure on the ECB to rein in its money-printing efforts.

What to buy now

The best thing for everyone would be for oil prices to fall back. Trouble is, you can't guarantee that will happen. A recession would knock prices back down, but by then, the damage is done. A peaceful resolution to the crisis in Iran would help but it's hard to see how that can happen unless Iran suddenly backs down on its nuclear programme.

As a British investor, this means you should plan for your struggle to keep ahead of inflation to continue. I'd get some exposure to the dollar. Also, remember to take advantage of your individual savings account allowance (Isa) you need all the help you can get to beat inflation. And if you're looking for something to put in your Isa, but don't want to take the risk of buying ordinary stocks, you could consider the slightly-less-risky preference shares.

This article is taken from the free investment email Money Morning. Sign up to Money Morning here .

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John Stepek

John is the executive editor of MoneyWeek and writes our daily investment email, Money Morning. John graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.

He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news. John joined MoneyWeek in 2005.

His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.