Energy inflation is likely to become stronger than is currently priced in by markets and the only solution is lower demand, which requires a recession.

A global markets research update from Japanese bank MUFG said “ESG-induced under investment” is resulting in higher refinery crude runs and that 10-month high crude oil prices may be projecting a false sense of security when it comes to energy inflation, which the bank said matters for monetary policy.

The bank said oil refiners buy crude oil, but the real economy is exposed to refined petroleum products, and while the prices habitually correlated, the correlation has broken down.

“This signals that energy inflation is set to become far stronger than likely priced in by markets,” the research update said.

MUFG cited commodities trading house Guvnor Group, saying that the refining system is ‘crying out’ for fresh investment, with oil demand still rising’.

“As we have continuously catalogued, the old carbon economy still needs investment until the green transition is complete, otherwise the global economy risks hitting capacity constraints on growth,” the bank said.

ESG investing influences future capex plans, the bank said, adding that limited stocks and marginal excess capacity signals that the only solution is lower demand. “For that, however, a recession is necessary,” the update concluded.

The ESG bond picture

Research published by BofA said ESG bond inflows in the year to date were coming close to inflows for the whole of 2022.

The bank said inflows of $21 billion were recorded from January to July 2023, whereas $22 billion of bond inflows were recorded for the entirety of 2022. By the end of June, 12.2% of global bond funds were ESG funds, measured by number of funds.

Western Europe remained the most important region for ESG fund flows, the BofA Global Research report said, accounting for 42% of global inflows in the year to date.

In emerging markets, following outflows from March to June totalling $722 million, ESG bond funds almost fully recovered in July with $683mn in inflows.  

The role of recent oil politics

Swiss private bank and wealth manager Julius Baer described recent production cuts by Saudi Arabia and Russia as ‘‘a blunt way to prop up prices and cash flows’ and with a fundamental impact that is less straightforwardly price positive.

Norbert Rücker, head of economics and next generation research said current oil prices of $90 per barrel defy fundamental dynamics and that the oil market is likely to tighten in the short term, softening and reversing next year based on both supply and demand dynamics.

“Saudi’s solo effort is unsustainable, and the petronations will need to shift back to more equal output levels. Iran’s growing exports and the United Arab Emirates’ production hike next year could be the triggers,” he concluded.

(Reporting by Imogen Lillywhite; editing by Seban Scaria)