Crude oil prices are back on the investors’ traders’ radar as oil prices hover around two-and-half-year highs at just above 76 USD a barrel, points out Darren Winters.
The trajectory of crude oil prices is another important factor in the equation, bearing in mind crude oil prices are a large input cost for producers of goods and services. Crude oil prices have an impact on a micro-level in that business profitability is determined by the crude oil prices
The more energy, oil dependent the business is, the greater the headwind rising crude oil prices will have on the business’s bottom-line, particularly if the demand for its goods or services is price elastic.
Leisure travel and food production both consume energy, particularly oil, but the latter demand is less price elastic
In other words, as crude oil prices rise companies providing necessities can absorb the higher input price from higher crude oil prices by raising their prices.
Put another way higher crude oil prices are a headwind on household discretionary spending, which is defined as money spent by consumers on things other than necessary things such as food, clothes, and fuel.
What is the implication of higher crude oil prices for investors?
Cyclical stocks are impacted by macroeconomic factors such as household spending.
Cyclical stocks represent companies that make or sell discretionary items and services that are in demand when the economy is doing well. They include restaurants, hotel chains, airlines, furniture, high-end clothing retailers, and automobile manufacturers.
Higher energy costs reduce household discretionary spending, which hurts cyclical stocks
Moreover, investment capital flows could be impacted by higher oil prices as investors rotate their portfolio away from cyclical stocks to more defensive assets in anticipation of an economic downturn.
But if the mechanics of the above is bang on the money, then could a persistent period of high crude oil prices lead to also lower cyclical stock prices?
So, as Darren Winters points out, another big factor in the equation is the Fed and its monetary policy and the question is at what point would the Fed address the inflationary pressures from rising crude oil prices.
Prices in 2021 are expected to increase at a 3.4% rate, compared with the 1.7% projected as of last September, according to the Fed figures.
The Fed’s transitory inflation view would not hold water if crude oil prices continue climbing
What would the Fed then do, with US worker participation rates still around 60%, which is near what it was in the 70s and a far cry from the Fed near full employment target?
So, with crude oil prices likely to head higher, albeit, in the short term, the Fed might decide to let inflation head above its 2% mandate, which it has already done, and continue to downplay it as merely transitory inflation.
But there is a risk also that the Fed’s transitory inflation could morph into stagflation, which is defined as persistently high inflation combined with high unemployment and stagnant demand in a country’s economy.
Higher crude oil prices could weigh on the Fed’s monetary easing policy
Crude oil prices are currently adjusting to a supply-demand imbalance as the global economy opens in the wake of the pandemic and is back to guzzling oil. Meanwhile, oil cartel OPEC+ is still withholding some 5.2 million bpd from global supply. Moreover, oil cartel OPEC+ is in no hurry to increase output, which was underscored by a July OPEC+ meeting to stall output cuts.
But nobody should be surprised by OPEC+’s latest strategy to keep supplies tight, after all a cartel forms a pact to extract monopoly profits.
Darren Winters says, he would not be surprised if future meetings to reduce global oil supply cuts would also be delayed
Right now, oil cartel OPEC+ has yet again delayed a decision to hike oil production, sending crude oil above 76 USD per barrel.
How much higher could crude oil prices go?
There is chatter amongst some CEOs and a few ultra-bullish oil analysts that crude oil prices could jump to 100 USD due to the supply-demand imbalances. Others are less bullish, believing that crude oil prices could still head higher in the 80s USD range a barrel.
Darren Winters comments that he would not be surprised if we saw further US inventory drawdowns in the US, with the peak driving season likely to add to demand as people travel to see friends, family, or getaway after a year of lockdowns.
Some oil analysts believe that the major oil producers would need to supply at least an extra 2 million barrels per month on global markets to keep crude oil prices down by a few dollars a barrel from current prices.
So that would mean an extra 400 million barrels per month to keep markets balanced
But with OPEC+ has already conveniently been unable to agree on production increases, so crude oil prices could quite easily head into the 80s USD per barrel.
Then there is always the seasonal bullish wild card, hurricanes in the Gulf of Mexico that could make the ultra-bullish triple-digit crude oil price come true.
Headwinds on crude oil prices could also give the bears a run for their money
The 2022 OPEC+ pact on production cuts of 5.8 million bpd expires in April 2022. So global oil supplies will be increased next year
Moreover, the Delta variant of the virus is spreading around the globe. Some cities in Australia and Asia into lockdown.
The black swan event, the pandemic lockdowns, which sent crude oil into negative prices, is still gliding around.