Higher oil prices threaten the downward trajectory of inflation
High oil prices are the biggest threat to the global disinflationary trend; with supply cuts set to remain in place for the next several months, higher oil prices will likely keep inflation higher for longer in most markets. This has implications for consumer spending and the recovery of purchasing power: higher prices at the pump eat into consumers’ disposable incomes and divert spending away from other goods and services. They also lead to higher input costs for businesses, which will threaten margins and complicate pricing decisions, given already-elevated customer price sensitivity. Finally, higher oil prices have the potential to delay the interest rate cuts expected in 2024, keeping the cost of credit higher for longer and further dampening economic activity.
Overview
- Following a subdued first half of the year, oil prices have rallied to the mid-90s over the summer, off the back of continued supply cuts by the world’s major exporters: Brent crude is up by 26% since early July.
- Russia and Saudi-led OPEC both announced that they would extend their voluntary production cuts through the end of 2023: the global supply shortfall is estimated to reach between 1 and 3 million barrels per day (bpd) in Q4 2023.
- Despite a sluggish outlook for global growth, these continued shortfalls in supply are likely to keep oil prices elevated for the foreseeable future.
- FrontierView expects oil prices to average US$ 84 in 2023, and US$ 89 in 2024 (Brent crude, USD/barrel), marking an upward revision over our previous forecasts.
Our View
2023 could very well prove to be a tale of two halves when it comes to oil prices: in H1, they confounded expectations by remaining lower than expected, as negative sentiment around the global macroeconomic outlook drove sluggish demand as well short-selling.
Since then, global oil supply has tightened considerably. The Organization of Petroleum Exporting Countries (OPEC) has implemented two supply cuts and extended them throughout the rest of 2023. The cuts have been predominantly driven by Saudi Arabia, which aims to keep prices elevated (around the high 80s) to fund its Vision 2030 growth program. Meanwhile Russia, still the world’s second-largest oil exporter, has itself extended voluntary supply cuts as it seeks to maximize energy revenues in the context of currency weakness and deteriorating public finances. Together, the reduction in output by OPEC and Russia represents a significant cut to supply, totaling around 3.5 million bpd.
This will be offset, but only partially, by increasing supply in non-OPEC countries. Notably, Iranian oil exports have been steadily increasing over the course of 2023, to the tune of 1.5 million bpd, as the West loosens sanctions enforcement amid informal attempts at nuclear negotiations. However, the arrangement remains fragile and could be reversed on short notice. In the US, oil production has been increasing and now hovers near pre-COVID levels, but tougher regulations have dampened sentiment in the US extractives sector, making further increases in output unlikely. The US is also unlikely to make significant drawdowns from its Strategic Petroleum Reserves (SPR) again: at 350 million barrels, they stand at around half their historical average, and further drawdowns for any sustained period of time (more than one to two months) would be politically and logistically difficult, if not unachievable.
Despite the tightness of oil supply, the current makeup of the global macroeconomic outlook provides a ceiling to oil prices. With the world’s three major economies (the US, China, and Western Europe) all set to underperform in the first half of 2024, demand is unlikely to increase substantially. This effect will be compounded by the continued recession in the manufacturing sector, itself driven by high credit costs and continued sluggishness in demand for durables and capital equipment. Still, strong demand elsewhere, notably India and Southeast Asia, as well as the continued recovery of air travel, will help partially offset this. In the second half of 2024, a global pickup in activity helped by rate cuts and improving purchasing power will provide renewed upward pressure to prices.
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