Economy, Global Economy, Covid-İnduced Recession

Economy, Global Economy

Boon and bane of soaring crude

Boon and bane of soaring crude

23/10/2021 8:22:00 AM

Boon and bane of soaring crude

THE global economy is gradually overcoming a Covid-induced recession and consumers’ pent-up demand is underpinning the recovery.

In fact, consumer demand that re-emerged as with the easing of pandemic restrictions has been fuelling the market.A surge in demand while supply is still struggling to cope due to movement restrictions to contain the virus spread has added pressure to the cost of production. This was further exacerbated by the ongoing supply chain crunch and energy shortage issues.

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With both coal and natural gas prices ballooned to record levels as a result of the severe demand and supply mismatch dynamics in the energy market and under-investment in their production, some effects are starting to spill over into the crude oil market following its plummeting price in 2020.

Alongside a drawn-out supply constraint from Hurricane Ida, the unwillingness of Opec+ to step up its supply to cater to excess needs has resulted in a sharp jump in oil prices. Currently, Opec+ are sticking to the previously agreed deal of 400,000 barrels per day.

This has propelled the price of Brent per barrel by a whopping 65% over the last 10 months from US$51.80 (RM218.18) at the start of 2021 to US$85.80 (RM356.41) on Oct 20. It is a level we have not seen since 2018. Coal prices surged by 189% while natural gas spiked by 103% over the same period.

Expectations are that this bullish trend will last longer in parallel with the supply chain bottlenecks. Additionally, a colder winter in the northern hemisphere could mean added demand for heating oil. If the situation continues well into 2022, the full-year average price of Brent could surpass US$70 (RM290.78) per barrel.

Winners of surging pricesThe surging prices of crude oil spell a flood of cash for oil exporters and producers, especially big players such as Saudi Arabia, Russia, Iraq, the United Arab Emirates (UAE) and Canada. Oil and gas producers in the Arabian Gulf are bound to reap the advantages of higher oil prices this year.

For instance, both the UAE and Qatar are expected to see their net exports climbing more than 10% of gross domestic product compared with 2020, followed by Saudi Arabia.Petroleum and commodity exporters can expect the gains to easily offset the losses they made in 2020 when the Covid-19 pandemic was at its peak, obliterating demand for commodities.

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According to estimates, a sizeable US$280bil (RM1.16 trillion) transfer from exporters to importers when prices shrank last year will be offset by as much as US$550bil (RM2.28 trillion) in 2021, about twice the size of the losses.Analysts anticipate that Russia will benefit the most with its net exports reaching almost US$120bil (RM498bil) in 2021. Other commodity or petroleum exporters such as Australia, Saudi Arabia, Brazil and the UAE will follow suit, with additions of more than US$50bil (RM208bil) each.

On the domestic level, Malaysia is also expected to benefit from the current situation. Considering that Malaysia exports liquefied natural gas (LNG) and petroleum products to other countries, revenue from oil and gas is expected to improve. Also, the national oil firm Petronas is expected to strengthen its cashflow.

LosersMeanwhile, oil prices and inflation are connected in a cause-and-effect relationship; oil prices climb, inflation tends to follow in the same direction.The dynamic is particularly true because oil is a major input in the economy and in doing businesses during the current pre-renewable energy era.

It will adversely impact economies around the world, including oil exporters, and the effects on low-income economies could be devastating.A big chunk of emerging economies that are still trying to claw their way out from the Covid-related recession will therefore find the surging inflation worsening their fiscal burdens.

On one hand, the elevated prices will directly impact millions of people through the higher cost of living. On the other hand, inflation also constrains the work of governments and central banks in formulating appropriate fiscal and monetary policies.

When the energy-driven inflation materialises, policy tools such as higher fiscal spending and lower interest rates or quantitative easing will further drive inflationary pressures.Additionally, currency depreciation, a rise in external debt, rising bond yields and potential credit rating downgrade could further raise the cost of funds from under-pressure fiscal and external accounts.

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Ultimately, we can attribute these consequences from rising crude import values.Oil importing countries such as China, India, Japan, South Korea and Germany will bear the brunt as the much needed commodity becomes more expensive.Most of Western Europe will also take a hit as they are forced to spend more on commodity imports. Japan, specifically, has suffered from a weakening yen when it shed 10.8% on a year-to-date basis as importers need to sell more yen for the greenback to procure oil.

Other losers are Asian nations like Vietnam and Bangladesh, which are already affected by the elevated price of oil.Situation remains fluidAs the surging inflation notion settles in, this could prompt central banks to tighten their monetary policy to moderate the price level.

More central banks have started mulling gradual departures from pandemic-induced and super-accommodative monetary policies, especially when economic growth gains traction or adverse effects of high inflation rate start to appear.This is so from the more hawkish central banks’ standpoint whereby they intend to prevent the economy from overheating. But Japan and many others remained behind the curve as they fear the downside risk from a sudden tightening could stall their recoveries.

In summary, the economic unknowns remain. Such a scenario can act as an added factor to weigh on the crude oil price. Uncertainties in the upcoming months may prompt investors to re-evaluate their portfolio and risk management strategies.Following the Delta variant outbreak, the easing pandemic restrictions will give way to public fiscal and monetary stimulus and the reopening of economies.

Investors may seek signs on the outlook for growth and if it will be challenged by various factors such as inflation and slower growth, and move away from commodities.Also, the wild card in the global supply and demand equation is global trade relations. Any major escalation in trade wars between major economic powers, particularly the US, China and the EU, will also crumple spending, investments and industrial activities, thereby limiting oil demand and pressuring the prices.

For FX enquiries, please contact:ambank-fx-research@ambankgroup.comFor Fixed Income enquiries, please Read more: The Star »

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