The returning theme in the latest set of monthly supply-demand reports has been decreasing supply from producers outside the OPEC+ alliance and gradually improving global oil demand, which is the function of vaccination programmes, however sporadic they are. This view resonated through the weekly Petroleum Status Report yesterday. The most important aspect of the statistics was that it lived up to expectations. Production and refinery shutdowns caused by the tempest in the Gulf of Mexico was still felt across the spectrum and quite possibly will have an impact on production, stocks, and export/import levels for a few more weeks.
The bottom line is that stocks in major categories have all fallen again – crude oil by 6.4 million bbls, gasoline and distillate by a little less than 2 million bbls. The lion’s share of these draws occurred in PADD3 where refinery utilization fell another 3% after the 17% dump the week before as crude oil supply is still scarce. Products supplied, generally a proxy for oil demand but in the last two weeks more of an indicator of refinery utilization, stayed resilient just below 20 mbpd week-on-week after a 3 mbpd fall in the immediate aftermath of Hurricane Ida. Commercial oil inventories declined by 9 million bbls last week and 19 million bbls over the past fortnight. This will inevitably have an impact on OECD stock movements in the next month or two.
Tighter oil balance is expected in the US as well as globally for the rest of this year, which should, at least in theory, lead to stable prices. Whether the often cited $80/bbl target basis Brent will be achieved before the year-end depends on financial factors. Stock market sentiment can turn in case of flare ups in infections or if monetary support is withdrawn due to fears of inflation. A strong dollar could cap further gains in oil prices and hints of stuttering Chinese economic growth and regulatory crackdowns can also have an adverse effect on investors’ confidence. Those who believe that oil price levels are ultimately decided by the supply-demand balance and inventory levels will view any set-back in prices as temporary before the move higher resumes.
Is inflation a genuine worry?
The recovery from the destruction caused by the coronavirus is genuinely under way. The pace of it might have slowed in recent months and every now and again speed bumps create obstacles that takes time to overcome but generally speaking the world is on the mend. The finish line is still far away, (actually sometimes it seems that it is being pushed further back) but global and regional economic growth is a firm indication that the worst is behind us. After the initial shocks governments are learning to cope with the virus and at the same time support their economies to the perceived best of their abilities.
With this gradually improving backdrop comes the next headache: inflation, how to deal with it and how it would impact our segment of the global market, oil. Inflating prices are the combination of three factors: rising aggregate demand, fiscal and monetary stimuli and supply constraints. Inoculation programmes, regardless how uneven or unfair vaccine distribution has been, have led to the lifting of lockdowns and to easing mobility and travel restrictions. The beginning of the year was cathartic, consumer confidence and spending skyrocketed providing a massive boost for the economy. Support from governments and central banks provided an additional adrenalin shot creating extra demand. One of the direct consequences of the unprecedented jump in aggregate demand is rising prices.
The other factor behind climbing inflation is supply constraints. We are currently living in a world of shortages of everything. Raw material prices are at multi-year highs, the gap between output of eurozone factories and the orders they are required to fulfil is the widest for 24-year, the diminishing availability of a wide range of materials, including plastics, woods, semiconductors, and metals, make it impossible for manufacturers to keep up with increasing demand. Supply chain bottlenecks and container shortage also greatly contribute to rising producer and consumer prices.
Inflated prices threaten economic growth, and the dilemma policy makers are facing is how to deal with it. Has the time come to withdraw stimulus measures, tighten monetary easing, or even increase interest rates? There is no consensus on the issue. Some would point to Tuesday’s US consumer price data and say that the inflationary pressure will be transitory whilst others argue that supply chain bottlenecks will ensure upward price pressure will persist in the foreseeable future. Some countries, especially in the developing part of the world, have taken pre-emptive steps and have already raised interest rates – Russia and Brazil amongst others.
Western economies, the US and the EU, have so far been able to delay this crucial decision. The Federal Reserve has been talking about tapering its bond-buying programme with no clear dates published yet. Last week, the ECB president Christine Lagarde said that “the lady is not for tapering” although she announced to slow down the pace of the bank’s pandemic emergency purchase programme, whatever the difference is between the two.
Where does oil fit in all of this? The impact of scaling back on quantitative easing and raising interest rates, ie, leaving the market on its own device, would initially be negative for risky assets. The dollar would likely strengthen, equities would cheapen and consequently oil would also suffer. After all, aggregate demand will suffer by withdrawing central help. The disappointment, however, might turn out to be short-lived – the reason for the tapering and scaling back help is recovering economies that will be able to stand on solid legs. Once the pandemic is irrevocably beaten global growth could well be able to expand in its own right supporting oil consumption and helping oil prices remain resilient.