|30 April, 2019

Will volatile oil prices threaten global growth?

Lukman Otunuga is a research analyst at FXTM. A keen follower of macroeconomic events, with a strong professional and academic background in finance, Lukman is well versed in the various factors affecting the currency and commodity markets. Lukman holds a BSc (hons) degree in Economics from the University of Essex, UK and an MSc in Finance from London School of Business and Finance, where he studied corporate finance, mergers & acquisitions and the role of international financial institutions.

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Are oil exporters set to experience short-term gains, but longer term pain?

United States President Donald Trump’s decision to end sanction waivers applied to countries buying oil from Iran could not have come at a more disruptive time for the global economy.

Persistent concerns over slowing global economic growth have eroded market sentiment, while geopolitical risk factors and trade war fears continue to drain investor confidence. With US sanctions on Iran compounded to the uncertainty and boosting oil prices in such a delicate period, this could be a recipe for disaster for global markets.

It is widely known that oil markets remain extremely sensitive to reports revolving around anything to do with supply and demand side factors. This was illustrated last week after oil prices rushed to fresh 2019 highs on the news of the U.S. ending waivers on Iran sanctions, only to later surrender all gains following statements from Trump that he had called OPEC to discuss increasing output. Regardless of recent declines, oil prices are likely to be driven by concerns over possible supply shocks in the near term. The prospects of roughly one million barrels being removed from the international oil markets will most likely fuel speculation of tightening conditions, especially when factoring in OPEC-led supply cuts and disruptions in Venezuela and Libya.

Supply shocks

Although OPEC+ can come to the rescue by using spare capacity to plug the hole, it may end up leaving markets susceptible to unexpected supply shocks amid heightened geopolitical risks. Even if the biggest producers in the cartel want to make this move, it will have to be in accord with other OPEC members as some may not welcome the idea of boosting production, which may result in lower oil prices.

Should oil prices ride on the supply threats and venture higher, this could have undesirable consequences on the world economy. While there will be winners from resurgent oil prices such as oil-producing nations, it is the sheer number of losers that have the ability to drag down the global economy.

Emerging markets that are struggling with current account deficits and a weaker local currency will be punished the most by higher oil prices, especially energy consumers. If the contagion from a deceleration in the emerging market infects developed nations, fears are poised to intensify over the global economy decelerating.

Although U.S. oil producers may take advantage of higher oil prices, it may end up pinching American consumers in the form of rising petrol prices – something that may bite back at President Trump, who wants lower oil prices.

Even if oil bulls remain in the driver’s seat, is there enough petrol in the tank for prices to journey towards the widely-discussed $100 level? A key giveaway is the fact that oil bulls remain mostly driven by concerns over supply disruptions rather than strong demand from robust global growth. Given the many uncertainties, such as Trump, the outlook for global growth, US shale production and trade developments revolving around oil markets, the longer-term outlook remains an open question.

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