What is happening in the oil market

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Today the ONS released May data for prices. The headlines are telling us that consumer prices annual growth is stable at 2.4% and that producer output prices are up by 2.9% from 2.5% in April.

This blog will look at these data a little bit more in detail and also in light of what is going on in the oil market.

CPI moving towards 2% but your personal inflation is way higher if you are travelling by car

In May, consumer prices grew by 2.4% which is the same annual rate registered in April. However, when looking at the breakdown, the picture is quite heterogeneous.

Items such as clothing and communication services grew less than the average (1.5% and 0.7% respectively). On the other hand, transport cost were up by 4.7% as a result of fuel prices increase. Diesel’s price was up by 3.8% in the month and 8.9% in the year. The situation for petrol is not much better with a monthly growth of 3.8% and 8% in the year.

As a consequence, transport services were up as well, in particular those extremely reactive to higher oil prices. Passenger transport by air increased by a whopping 8.2% in the year.

I hope you have already bought your ticket for your next summer holiday!

 

Input producer prices are running extremely fast

High oil prices clearly affect consumers, however, excluding pump prices which are usually fairly reactive, the process is generally more gradual and distributed over time.

The same cannot be said for producer prices which are way more erratic. As a confirmation, input producer prices grew by 9.2% in the twelve months to May due to an annual 40.2% crude oil input price increase.

 

Output prices are more stable and this will hit margins

Factory gate prices are also rising – 2.9% in the year to May – but not as fast as input prices. Producers cannot react too quickly to change in input prices to avoid losing market shares, but this will clearly hit margins and companies’ profitability.

The major contributor to the increase in output prices is clearly petroleum products, followed by chemicals – a sector that uses a lot of energy (as we have already explored in our sector bulletin).

 

So, what is happening on the oil market?

Back in December, we published an analysis on the oil market which took into account its fundamentals but also the political and fiscal reason behind it. You can find it here.

Most of what described there is still applicable, however an update on this will be beneficial.

 

In May, Brent price reached a level not seen since 2014

On May 22nd, Brent price touched its highest price in four years at 80.42 US dollars per barrel.

 

Oil_price 

As can be appreciated from the graph, the price is the result of a long period of price growth and, as we underlined in our previous analysis, this was mostly due to the deal signed by OPEC and some non-OPEC countries (namely Russia) to cut down production in order to increase price and help their fiscal budget which remain highly dependent on oil revenues.

 

oil_production
 

 

The cut in production was also unintentionally helped by the disastrous situation of Venezuela. The country was the 6th largest producer in 2009 and by several estimates is sitting over the largest oil fields in the world. However, the bad administration of these last years have created such an unproductive environment that the production of oil has been halved (the country is now 12th in the world oil producer ranking).

 

oil_production_small 

 

But it appears that June prices are moving in the opposite direction

If it’s true that the price peaked in the fourth week of May, since then they started to move on the opposite direction and this appears to be the result of different factors.

The first one is related to shale oil production in the US and, to a lesser extent, Canada.

 

oil_rigs

  

Higher oil prices had the effect to make profitable some oil basins which have not been exploited for a while. As the graph points out, the US rig count is up and it’s running quite fast.

According to JODI, an organization providing oil and gas international data, in March the US has overtaken Russia and Saudi Arabia as largest oil producer in the world.

However, it is worth to point out that even if new oil rigs are quite fast to be built, the same cannot be said about oil pipelines and infrastructures. At the moment, it appears that the US is able to produce a lot of crude oil, but its transportation to refineries is not that efficient creating some supply constraints.

 

The second and probably more important factor behind the slowdown of oil prices is related to geopolitics. As we mentioned in the past, the OPEC plan worked perfectly thanks to high commitment of signatories to actually reduce and then stabilize their oil production.

However, it appears that something has been broken and several countries have started to increase their production once again.

On June 22nd, a new OPEC meeting is expected and some of the tension between country members may have a final showdown. In particular, the situation appear to be increasingly tense between Iran (recently hit by new US sanctions) and Saudi Arabia (a long established US ally) which have also engaged in proxy-war in Yemen and fought for political control over the Middle East in the last years.

Markets may have start to bet on a reduction or stabilization of prices, but it’s clearly too soon to say if they are right.

 

 

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