When the price of oil rises, the price of everything else rises. It’s a near-universal rule owing to the fact that virtually all goods and services involve the use of oil at some stage of the supply chain that brings them from producer to consumer.
The most unwelcome consequence of this rule is that when economies are in an already precarious situation, inflation-wise, higher oil prices are the last thing they need. And yet higher oil prices are exactly what the troubled U.S. and European economies are currently getting. And it might get worse.
The latest U.S. consumer price index revealed an increase of 3.5% for March on an annual basis. The number was higher than expected and immediately put an end to talk from Fed officials that the coming months could see the start of rate cuts after an extended series of hikes aimed at reining in the latest bout of worrying inflation that followed the pandemic and the start of the war in Ukraine—which happened to be marked by a surge in oil prices.
Following the release of the CPI report, oil prices retreated. It is the natural reaction of traders to sell when they sense bad inflation news. But this won’t help with the supply problems that a growing number of analysts are noting. So is OPEC.
The cartel published the latest edition of its Monthly Oil Market Report on Thursday, leaving its demand forecast for this and next year unchanged: for this year, OPEC expects demand growth of 2.25 million bpd. For next year, it sees growth moderating to 1.85 million bpd. Demand for OPEC oil was seen at a bit over 28.5 million bpd this year and 29 million bpd in 2025.
If these numbers turn out to be close to actual demand growth, the world will swing into a deficit quite soon: OPEC’s latest production numbers are for a total of 26.6 million bpd, which is well below the projected demand figure for 2024.
Now, that leaves a gap of close to 2 million bpd to be filled by non-OPEC supply, but this won’t be happening if we are to believe the U.S. Energy Information Administration, which recently updated its production forecast for the year and saw it at 280,000 bpd. The figure is 20,000 bpd higher than last month’s production growth estimate but still nowhere near high enough to make up for the shortfall that OPEC has predicted. And there is no other producer capable of doing this.
What this means is that the Federal Reserve’s decision to delay the start of rate cuts will hold for longer than many must have hoped. It also means that the European Central Bank’s decision to keep interest rates in the eurozone unchanged at the record high of 4% even though March inflation surprised positively, declining to 2.4% from 2.6% from February.
If the ECB was reluctant to start cutting rates with an inflation rate of 2.4% in a month when energy prices fell, it is likely it would be even more reluctant to start cutting when energy inflation swells. And swell it will, with the deficit looming over oil markets and, specifically for Europe, on gas markets, too, as Russian attacks on Ukrainian gas storage sites remind Brussels that the end of gas price trouble may not have been permanent.
Geopolitical developments in the Middle East are not helping, either. Bloomberg stoked up Iran attack fears on Thursday by citing unnamed sources as saying that the U.S. and its allies saw the attack as imminent, potentially happening over the next few days. The attack, per the report, would likely pick a military rather than civilian target in Israel, the sources also said.
Not all are convinced this will happen, however. Energy analyst Neil Atkinson recently told Al Jazeera that Iran was, in fact, unlikely to retaliate for the Israeli strike on Tehran’s Damascus consulate with a direct attack on Israel. Iran plays the long game, Atkinson said.
Even without a blowout between Iran and Israel, the balance in oil markets is not looking bearish for prices. The International Energy Agency is publishing its own monthly oil report today and may try to counter the growing fears of a shortage with its demand growth forecast. On the other hand, it may revise it upwards again, which will strengthen prices further.
Analysts like to stress the fact that high inflation kills oil demand. What they rarely mention these days is that this demand destruction is always limited—because oil is an essential commodity for any relatively industrialized economy on the planet. In other words, the interest rate cut disappointment that drove benchmarks lower earlier this week is not going to hold for very long because oil demand has repeatedly proven more resilient than many have expected—and hoped.