TOKYO – If OPEC’s plan is to derail economic recoveries from China to the US, then this relic of the 1970s is off to a smashing start to 2021.
Even deflation-plagued Japan is at the statistics board, penciling in jumps in energy-driven producer costs that get it closer to a 2% consumer-price level than it’s been in 30-plus years.
There are few more sobering reminders of how fragile post-Covid-19 recoveries are than oil surging to US$100 per barrel.
“Undoubtedly, the rise in crude will lift inflation until the end of the year,” says economist Lee Hardman at MUFG Bank.
And what about after that? Welcome to Asia’s hellish balancing act.
The problem for policymakers from Seoul to Jakarta is figuring out which is the bigger threat: rising oil demand or strained supply. Thanks to the anachronism known as the Organization of the Petroleum Exporting Countries, it is both.
The first dynamic is gaining steam as moves to reopen economies around the globe have consumers racing to make up for lost time and spending. Hence, the demand surge driving up prices. That second one is proving quite a wild card as oil-producing nations squabble over increasing production.
Oil bulls versus oil bears
With oil prices above $70 per barrel, markets had assumed OPEC would act to preserve pandemic recoveries. So far, cooperation seems in low supply as Saudi Arabia and the United Arab Emirates trade barbs.
The Saudis back increased production, but the UAE is resisting – pushing back over the size of its production quota.
Oil isn’t the only commodity surging toward 2014 highs. So are the prices of everything from metals to lumber to basic agricultural products. But oil is the most avoidable pressure point of the year so far.
One reason traders were disoriented by this week’s price action is how differently markets responded this year and last year. In 2020, prices fell after OPEC and allies like Russia, or OPEC+, left a meeting without setting production quotas. This time, prices skyrocketed.
Oil bulls “may yet be proved right, but they are making some large assumptions, which deserve close scrutiny,” says analyst Tom Holland of Gavekal Research. He thinks punters are making three OPEC-obsessed assumptions that might end up being false.
One: there could still end up being an agreement to boost quotas. “It’s possible,” Holland says, “that cartel members Saudi Arabia and the UAE will patch up their disagreement.”
The tiff, he notes, may well have as much to do with Riyadh’s attempts to cajole multinational companies into relocating their regional headquarters from the UAE to the Saudi capital, as with how production quotas are set in the future.
Two: production quotas don’t always equal actual production. Over the last 15 months, compliance has been tight. But historically, OPEC+ members have shown a willingness to exceed their quotas as prices spike.
This tends to occur when members fear being blamed for geopolitical fallout – or if they feel threatened with losing market share to shale producers in the US and elsewhere.
With climate-change-related disasters from Miami to the Australian outback garnering global headlines and companies clamoring toward greater sustainability, OPEC members know that posterity is watching their every move.
Three: there’s always a chance that OPEC+ members might scatter. Could one or more major producers walk away to maximize production at the expense of remaining members?
For now, the benefits of OPEC+ membership still dominate and after 15 months of crashing commodity prices, oil producers are keen to refill their coffers.
But rancor has been the grouping’s calling card in recent decades. The mere fear of some key defections could, in and of itself, lead to an oil production increase. These implied threats may prove more influential than ever in 2021.
“As a result, the case for $100 oil this year is less clear cut than many market participants assumed on Monday,” Holland says. “All this matters greatly, because if the price of oil stalls out at $80 … and remains around that level for the rest of the year, the year-on-year increase in the oil price will slump from more than 80% currently to 56% by year-end.”
In other words, Holland says, “oil will no longer be fueling higher headline inflation rates.”
“On the other hand, if Brent climbs to $100 by the beginning of November, the year-on-year increase will more than double to 175%, contributing mightily to higher consumer inflation. As always, oil and OPEC+ bear watching.”
Such uncertainty, says analyst Louise Dickson at Rystad Energy, is “what may be creating an expectation for a deal that may be satisfying the UAE a bit more, thus a less bullish outcome than previously thought.”
Either way, Dickson says, the days ahead “could be a wild price ride in either direction.”
Analyst Alan Gelder at energy consultancy Wood Mackenzie notes that “OPEC works best when faced with significant challenges, which are now unwinding as demand recovers.”
Key learning for Asia? All the region’s business and political communities can do is cross their fingers and brace for whatever decisions cartel members make in the days and weeks ahead.
Wider inflation fears
Oil price spikes are the last thing a region suffering second, third and fourth waves of Covid-19 infections needs. A further fryer of nerves is the fears of a tapering amid the conflicting signals from the US Federal Reserve in Washington that have confounded Asian policymakers.
Memories are fresh from the late 2013 mini-panic in emerging markets over the Fed scaling back 2008-era easing moves. At the time, Morgan Stanley published a “fragile five” list – India, Indonesia, Brazil, South Africa and Turkey.
Today, India and Indonesia have even more company in Asia – the Philippines, for example – as aggressive Covid-era borrowing collides with inflation risks.
This is no new problem. After the 2008 collapse of Lehman Brothers, monetary authorities from Washington to Frankfurt to Sydney followed Tokyo’s lead to experiment with quantitative easing.
In 2019, before the pandemic arrived, central banks still had not exited history’s greatest interest rate cycle. Once the coronavirus arrived, they hit the monetary accelerators anew.
As economies reopen, there are bound to be upward price adjustments. One reason is base effects from the depths of mid-2020. On a year-over-year basis, cost spikes are dramatic. This expectation forms the core of arguments by central bankers that inflation is transitory and will ease as Covid disruptions fall away.
Commodity price gains are the most obvious flashpoint. In the US, so are the surging costs of everything from used cars to airfares to home rentals. This latter dynamic is both squeezing the finances of lower-income Americans and wreaking havoc with the US Labor Department’s basket of consumer price index inputs.
Statistics everywhere are becoming influenced by sudden spikes of confidence colliding with new risks charging over the horizon. In Canada, a resurgence of consumer and business sentiment points to a heady second half of 2021 – and perhaps upward price pressures.
In Germany, reports of supply bottlenecks are weighing on manufacturing just as spreading Covid-19 variants prod local governments to tighten restrictions anew.
Developing economies like Brazil, meantime, have been forced to issue only short-term debt to skittish global investors. Other members of the original “Fragile Five” are experiencing their own market reckonings.
India spent the last 30 years opening its giant, lopsided economy. The coronavirus undid much of that progress in a matter of months. Indonesia’s Covid-19 trajectory also has investors rethinking where they hoped Southeast Asia’s biggest economy might be in 2022.
Risk, uncertainty, risk …
OPEC complicates these carefully laid plans. Rising oil prices imperil China’s “V-shaped” recovery, upping the odds rising factory-gate prices bleed elsewhere. This comes as signs appear that China’s coronavirus bounce back is not as energetic as hoped.
In June, mainland factory activity slid to four-month lows. Though some of the softness reflects a shortage of semiconductors, fresh Covid-19 outbreaks in major export regions like Guangdong could change the calculus for China’s recovery.
For now, China’s official manufacturing Purchasing Manager’s Index remains above the 50 level denoting expansion – 50.9 in June versus 51.0 in May.
“This was largely a result of Covid, which has affected factory output and also new export orders due to the rising waves of infections and resultant restrictions in some neighboring economies,” says economist Iris Pang at ING Bank.
It hardly helps that China’s Covid vaccine is hitting some speed bumps amid efficacy concerns. This week, Singapore said those who received Sinovac Biotech’s shots will no longer be considered protected from the pandemic. This could be quite a blow to President Xi Jinping’s vaccine diplomacy ambitions.
The question is how oil approaching $100 per barrel adds to these headwinds. Concerns about “stagflation,” for example, are popping up thanks to a mix of tepid growth, frothy asset markets and rising energy costs.
As New York University economist Nouriel Roubini puts it: “The same loose policies that are feeding asset bubbles will continue to drive consumer price inflation, creating the conditions for stagflation whenever the next negative supply shocks arrive.”
And, he notes, it’s not just oil shocks about which global markets need to worry.
Shocks, he says, “could follow from” everything from renewed US-China protectionism to immigration restrictions to moves to re-shore manufacturing back to higher-cost regions.
Just as former President Donald Trump’s trade war contributed to the semiconductor shortages fanning inflation, tech nationalism could unleash unpredictable price dynamics.
Look no further than current US leader Joe Biden’s determination to bring to heel mainland companies listed in America. And Xi’s own efforts – as seen with ride-sharing giant Didi Global – to deprive US exchanges of Chinese tech initial public offerings.
Yet OPEC’s seeming nostalgia for 1970s-style runaway inflation could be the real disruptor for Asia. Internecine squabbling between petrostates is the last thing this region’s export-reliant economies need amidst a pandemic.
So much for hopes for a brighter, more vibrant 2022.