By Lucy Raitano
LONDON (Reuters) -Oil prices are up about 16% so far this year, near $90 a barrel, with supply concerns high given escalating tensions in the Middle East and tit-for-tat attacks on energy infrastructure between Ukraine and Russia.
Investors are paying attention. After all, it was a surge in energy prices two years ago that helped push inflation and interest rates up on a scale not seen in decades.
The International Monetary Fund on Tuesday described an “adverse scenario” in which an escalation of conflict in the Middle East would lead to a 15% jump in oil prices and higher shipping costs, raising global inflation by about 0.7 percentage points .
The tight oil supply and higher prices are supported by oil producing group OPEC and other major oil producers restricting their production.
Morgan Stanley has raised its forecast for the third quarter by $4 per barrel to $94. With oil prices expected to remain high, we look at the implications for global markets.
1/ INFLATION WATCH
After US inflation came in higher than expected for the third month in a row in March, the specter of higher inflation has returned as bets on rate cuts have been sharply scaled back.
Falling energy prices have been one of the main drivers of lower inflation expectations recently. Higher oil prices are seen as a threat to this trend.
A key market gauge of long-term inflation expectations in the euro zone, which generally tracks oil, hit its highest level since December at 2.39% on Tuesday. The European Central Bank has an inflation target of 2%.
ECB chief Christine Lagarde said on Tuesday that new turbulence in the Middle East has had little impact on commodity prices so far. Although near a recent high, oil prices have fallen slightly this week.
Still, the ECB has said it is “very alert” to the impact of oil, which could harm economic growth and fuel inflation.
Guy Miller, chief strategist at Zurich Insurance Group (OTC:), said economies can survive, and producers are quite happy, if oil prices are around $75-$95 per barrel.
“But if we were to see this go higher, that would be a concern from both a growth and inflation perspective,” he said.
2/ GO ENERGY RECOMMENDATIONS
Energy stocks are a clear winner from higher oil prices. The oil index and European oil and gas stocks remain close to record highs.
U.S. oil stocks are up nearly 13% so far this year, outperforming the S&P 500’s broader 6% gain.
Ed Yardeni, founder of Yardeni Research, said a rise in Brent crude to $100 in the coming weeks is a possibility, and recommends an “overweight” position in energy stocks.
Oil was last above $100 in 2022. After the Russian invasion of Ukraine, oil briefly rose to around $139, the highest level since 2008.
“I believe you should consider energy as at least a shock absorber in your portfolio in case oil prices continue to rise,” Yardeni said.
Emmanuel Cau, head of Barclays’ European equity strategy, has been overweight European energy stocks since October. He says the sector tends to perform well in inflationary and stagflationary environments.
In contrast, Nordea CIO Kasper Elmgreen said he was negative on energy stocks because the costs associated with an energy transition were not yet priced correctly.
“They (the energy companies) will have to bear a much higher burden to reach net zero, and that is not reflected in the share price,” Elmgreen said.
3/ ROBUST DOLLAR
2024 started with expectations that the dollar would fall as inflation weakens and the Federal Reserve has a chance to cut rates.
Instead, the dollar is up 4.7% this year as interest rates have been cut.
Higher oil prices could boost the strength of the dollar.
Bank of America said that while the medium-term rate remained negative against the dollar, high oil prices meant the US currency faced “upside risks”.
That increases pressure on economies like Japan, which are struggling with a weak currency, leaving traders nervous about possible interventions to support a yen languishing at a 34-year low.
“The yen and the euro will see their terms of trade deteriorate as energy prices rise. This implies that they will be weaker as energy prices rise,” said Colin Asher, senior economist at Mizuho Corporate Bank.
4/ FRESH EM PAIN
Higher oil prices will also hurt many emerging market economies such as India and Turkey, which are net oil importers.
The Indian rupee hit a record low against the dollar this week.
Because oil is priced in dollars, many importers are also exposed to higher prices due to currency fluctuations.
Even in Nigeria, typically Africa’s top oil exporter, the plummeting naira currency has hit public coffers due to capped petrol pump prices and a lack of local oil refining.
