The heated geopolitical situation is again putting pressure on oil prices, threatening the progress on fighting inflation.
Oil markets took Brent oil prices above $92 due to the new Middle East crisis, but crude is still below its September highs. Rising prices are a double market threat: these are acting as a growing consumer tax and may also hit the lower inflation narrative, writes eToro analyst for Romania, Bogdan Maioreanu.
The oil outlook is highly uncertain but there are some elements that can act as offsets to price spike fears.
Economies are now less energy dependent and this makes OPEC less relevant. OPEC+ – the organization that includes other countries outside the Middle East, such as Russia and Mexico – supplies circa 40% of the current oil market compared to over 60% in the 1970’s. The energy needed to produce a unit of GDP has fallen by about 1.5% a year for decades, according to Enerdata.
The trend is driven by technological change, production efficiencies, and the shift to services. Over the last 30 years, the economies of the US, China, and Germany improved their energy efficiency by 63%, while Romania managed to cut its energy consumption per unit of GDP by over 73% since 1990.
Europe has some of the world’s lowest energy intensity, 40% below the global average, and this has been a key buffer amid the recent energy crises. The energy independent US sits at the global average, whilst manufacturing-heavy China is 30% above the average. The least energy efficient are the oil exporters plus Taiwan and Korea. Among the best are the UK, Romania, Italy and Spain.
The solution to high prices might well be …higher prices, as the old saying goes. Demand has been quick to react to prices above $90, making them ultimately self-correcting. We have already seen the corrective move from $95 to $85 per barrel in September. Oil markets are in deficit this year, with demand growing by 2.3 mbpd (million barrels per day) to 102 mbpd and OPEC cutting back supply.
Saudi Arabia has significant spare capacity, pumping 20% less than last year, and could move to soothe a price spike. Also, non-OPEC oil supply has been growing, with the US hitting a new record and rising production from Brazil to Guyana. The recently announced easing of Venezuela sanctions may also reduce some of the pressure.
Another factor is that oil prices are in backwardation. This occurs because supplies are already tight, causing inventories to fall, which in turn leads to even higher prices and supply concerns. In this way, although backwardation technically means the market expects lower prices in the future, it typically comes at a time when prices are rising. But if we look at the futures for 2024, markets are pricing Brent oil below $90 in February and below 85$ in September.
Iran is threatening to cut production, despite crude oil dominating its exports. It has been the 2nd largest source of new oil, after the US, and is 4% global supply. But we are not back to the 1970’s. So far we have not seen other countries in OPEC+ willing to join Iran’s supply threat. Swing producer Saudi Arabia may pump more. Also, previous wars in the region, after 2000, saw short-lived oil impacts.
As expected, markets have been worried about the new developments in the Middle East, but the effects so far have been relatively modest, with even the more energy intensive Dow Jones Industrial Average index dropping only about 2% over the last week, while being still up 9% compared to a year ago.
