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The meaning behind ‘crude oil forecasted to reach $100’

Major oil trading houses are foreseeing the return of $100 crude for the first time since 2014 as the Organisation of the Petroleum Exporting Countries (OPEC) and its allies struggle to compensate for US sanctions on Iran’s exports.

There are two sides of the same coin: the winners and the losers should the $100 level occur. Exporters of fuel would enjoy higher returns giving a boost to companies and government reserves. In contrast, consumers would bear the cost of such a rise potentially wafting inflation and hurting demand.

That being said, given that economies are less reliant on energy and the shale oil production revolution protecting the US, global growth should not be affected as much.

In the long run, it all depends on why oil prices are pushing higher. Both forces of constrained supply and robust demand are in action thus driving crude oil up about 22 per cent this year.

What does it mean for economies?

Higher oil prices would hurt household income and consumer spending but the impact would vary depending on the economy in question. There are also seasonal effects to consider, with winter approaching in the Northern hemisphere where warmth is needed. Consumers can switch energy sources to keep costs down, such as to biofuels or natural gas, but it’s easier said than done. Having said that, Indonesia has already instituted measures to push more use of biofuels and limit the economy’s reliance on imported fuel.

Europe is vulnerable given that many of the region’s countries are oil importers. China is the world’s biggest importer of oil and could anticipate an increment in inflation.

A run-up in oil prices poses a lot less of a risk to the US than it used to, thanks to the boom in shale oil production. Even though imported oil has positive economic consequences at the industry level, poorer households would feel the weight of higher prices directly. These spend about 8 per cent of their pre-tax income on gasoline, compared to about 1 per cent for the top fifth of breadwinners.

That being said, realistically, for a sustained hit to global growth, economists say oil would need to hold above $100. The dollar’s gain of this year doesn’t help though given crude is priced in dollars.

Inflation and Central Banks

Energy prices often carry a heavy weight in consumer price measures, prompting policy makers including those at the Federal Reserve to focus simultaneously on core indexes that remove volatile energy costs. A substantial run-up in oil prices could provide a more long-lasting increase for overall inflation if the costs filter through to transportation and utilities.

If stronger oil prices boost inflation, central bankers will have one less reason to keep monetary policy loose. Among the most-prone economies, central bankers in India have already warned about the impact as the nation’s biggest import item gets more expensive. Greater overall price pressures also could prompt economies such as Thailand, Indonesia, the Philippines and South Africa to tighten their monetary policy faster.

Winners and losers

Most of the largest oil-producing nations are emerging economies. Saudi Arabia leads the way with a net oil production of almost 21 per cent of gross domestic product as of 2016 – more than twice that of Russia. Other winners could include Nigeria and Colombia’s oil market. The increase in revenues would help repair budgets and current account deficits, allowing governments to increase spending and thus investing.

On the opposing side, nations such as India, China, Taiwan, Chile, Turkey, Egypt and Ukraine are among those that would take a hit. Paying more for oil will pressure current accounts and make economies more vulnerable to rising US interest rates. 

Is it likely to reach $100 a barrel?

Bank of America’s forecast for oil prices next year is of around $80 a barrel. Citigroup Inc. sees crude also at that level in the fourth quarter, but identifies the possibility of it going higher. Goldman Sachs analysts do not predict that $100 a barrel will be passed.

Balances of oil are unreliable and there is lack of supply thus the end result is volatile . In my opinion, and also according to the aforementioned views, it is only if all potential risk in the market materialise that we would see levels of above $90 or even $100.

Disclaimer:

This article was issued by Maria Fenech, investment manager support officer at Calamatta Cuschieri. For more information visit, www.cc.com.mt. The information, view and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice.

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