OPEC and the world’s most powerful central banks are on a collision course. Higher crude prices could push the custodians of the global financial system into tightening monetary policy quicker than expected to protect their economies from unchecked inflation. But, a kneejerk reaction could sow the seeds of economic slowdown, oil demand destruction and another price crash.
Take the problem facing Mark Carney, governor of the Bank of England. Lower-than-expected inflation figures released this week give the impression fears over the impact of higher energy costs in the world’s sixth-largest economy have been overblown. Since 2016, when oil prices dipped below $30/b, gasoline prices have jumped by almost 30% to an average around 127 pence/liter at the pumps.
And it’s not just vehicle fuel adding to the daily cost of life for British consumers and businesses. The price of almost every form of energy required for modern life is on the rise. Wholesale gas price futures have increased by almost 60% since 2016 close to 60 p/Btu, in what traders have described the “Trump bump”.
A similar trend is visible in UK power markets. Forward electricity prices have risen 32% over the last 12 months, prompting the Big Six retailers to hike bills in April. For example, British Gas’ 5.5% increase is translating into an extra GBP60 per year for a typical dual fuel customer already shelling out GBP1,200 a year on gas and power.
In theory, this should translate into higher inflation. Don’t be fooled by figures released this week by the Office for National Statistics. The consumer price index unexpectedly falling to its lowest level in a year is likely to be a short-lived respite. Economic experts agree that inflation and the British economy will eventually succumb to the rising cost of energy this year, forcing the Bank of England’s hand on interest rates.
“The rise in oil prices comes with unfortunate timing,” said Tej Parikh, senior economist at the Institute of Directors. “Buoyed by fast-falling inflation, households were becoming increasingly confident about their finances, while businesses were recovering from high import prices. But for the summer months at least, we’re likely to see some continued upward pressure on domestic prices and therefore restraint in consumer spending.”
At some point the rising cost of fuel will hit demand as households cut back on discretionary spending to ensure the lights stay on. Demand destruction is OPEC’s big fear as it seeks to rebalance oil markets in its favour in the wake of the US shale revolution. Oil prices crashed in 2008 from a peak of $147/b as the global financial crisis hammered consumers.
The International Energy Agency has already slashed its forecast for growth in daily demand by 40,000 barrels to 1.4 million b/d this year. The Paris-based industry watchdog now expects consumption of just over 99 million b/d, compared with 100 million b/d this year forecast by S&P Global Platts Analytics.
“With geopolitical tensions pushing up oil prices, higher fuel costs have partly countered the downward effect of weaker currency passing out of the figures, as these costs represent a key outlay for consumers,” Parikh added.
OPEC’s first chance to respond could come this week when senior officials and Russia’s energy minister Alexander Novak meet on the sidelines of an economic conference in St. Petersburg to discuss if a change in strategy is required to fend off further blame.
$5 A GALLON
Higher energy costs are also being felt across the Atlantic. Gasoline prices almost hitting $5 per gallon in one New York filling station this week made national headlines. Charles Schumer, the Senate Democratic Leader, seized on the opportunity to hold an impromptu news conference at a Capitol Hill pump station. Schumer has called on US President Donald Trump to put more pressure on his petro-dollar allies in the Middle East.
“It’s time for this president to stand up to OPEC,” Schumer told the gathered press. Although Trump has taken to Twitter to accuse the cartel of rigging oil prices his policies have arguably played into OPEC’s hands. Oil prices have spiked above $80/b since his executive decision to withdraw the US from international sanctions relief on Iran, the group’s third-largest producer.
Perhaps sniffing a political opportunity to wound Trump and tug at his grassroots support, Schumer and his Democrat colleagues wrote to the president urging him to dispatch Energy Secretary Rick Perry to read the riot act to OPEC in Vienna on June 22. The cartel is next scheduled to meet in the Austrian capitol to discuss strategy and whether to persist with 1.8 million b/d of cuts designed to rebalance the market. Some would say their mission has already been accomplished.
“The impact of rising fuel prices on our economy and on family budgets is significant and widespread,” wrote Schumer and his Democrat colleagues in the letter dated May 23. “According to a recent analysis by Goldman Sachs, the run up in oil prices will roughly cancel out the effects from tax reductions this year, with greatest impact on households that can least afford it,” it said.
Like the UK, higher fuel bills in America also mean inflation and a big problem for the world’s most important central banker, Federal Reserve Chair Jerome Powell. The Fed is expected to continue raising interest rates this year as it moves towards its 2% inflation target and that could have a big impact on the nation’s shale oil boom, which has provided an element of insulation against dependence on OPEC.
The US oil industry, which now pumps just under 11 million b/d of crude, is sensitive to higher borrowing costs because of the fragmented nature of production in the country’s shale fields. So called “Mom and Pop” drillers in the “Lower 48” are more dependent on debt and short-term loans to fund their daily operations. These tiny companies could be hardest hit by rate increases, unlike global oil majors with vast balance sheets to absorb the shocks.
“One of the aspects of the shale revolution is that the oil market I think is more open and more exposed to credit market flows now going forward than it was in the past because of the increase of this huge number of small, heavily geared, producers working with the Lower 48,” said Spencer Dale, group chief economist at BP and a former member of the Bank of England’s rate-setting Monetary Policy Committee, in a recent interview with S&P Global Platts.
It’s not just the likes of political opportunists such as Schumer, central bankers, or irate British motorists paying GBP70 to fill up their tanks, who are now pointing the finger at OPEC. India’s energy minister Dharmendra Pradhan spoke with his Saudi counterpart earlier this month about the havoc higher oil prices could cause in the fast-growing Indian economy. It’s time the cartel took notice.