Ongoing strength in the price of oil leads to growing fears of rampant inflation. How high can the price go for the rest of the year?
The price of oil rose above $66/barrel this week, reflecting the strong economic recovery after the COVID-19 pandemic shock. As the vaccination campaigns gain pace across the world, the global re-opening is reflected in higher forecasts for oil demand.
For example, the International Energy Agency (IEA) has upped its oil demand forecast by +230k barrels per day for the rest of the year. Naturally, stronger demand leads to higher prices, but how much is too much for oil?
This year the price of oil is one of the best-returning assets, if we discount digital assets such as the main cryptocurrencies. Oil has posed one of the greatest starts of the year in the last three decades, and now fears build that the rising prices will lead to higher inflation.
Iranian Production May Temper Oil Prices
OPEC+ did a great job in stabilising the oil market during the crisis. After the price of oil settled into negative territory in April 2020, it gradually recovered, and now most forecasters are upping their end-of-year forecasts. Some see even $100/barrel, but such a level is unlikely to be reached anytime soon, principally for the following reasons.
Firstly, such an elevated price for oil is not in the best interest of OPEC+ itself. The market participants are well aware of the fact that the cartel’s war with the US shale industry led to lower oil prices before the pandemic. Higher prices puts the shale oil industry back in business, and so competition from the US will harm OPEC+’s influence.
Secondly, Iranian production may hit the market sooner than expected. The negotiations, while slow and indirect, allow for optimism that a deal can be reached. If that is the case, the market must find a way to accommodate 1.5 million barrels of oil – a potential game-changer for the oil price in 2021.
Finally, there’s the COVID-19 pandemic. While the developed economies are well-advanced in their vaccination efforts, most of the world is still in the incipient phases. The world entered into recession at roughly the same time, but the way out will be gradual and uneven around the world.
If we take the aviation industry alone, for example, we see that the industry is still 25% below pre-pandemic levels as it is huge consumer of oil-derived products, such as kerosene. The gap will shrink further, but until then it weighs on global consumption.
All in all, the oil markets had one of the best starts of the year in history. However, at current levels, investors should express caution as the second half of the year poses numerous challenges.