Economic e-news - June 2018

15 June 2018

By Craig Turnbull
Chief Investment Officer


What has been pumping up the price of petrol?

Motorists across the country have been feeling the pinch at the petrol pump with average prices rising to a four-year high in June on the back of rising global oil prices.

A combination of factors including OPEC production cuts and more recently, US trade sanctions on Iran has pushed the Brent oil spot price beyond US$70 a barrel but is this trend likely to continue?

 

Source: US energy information administration

How have these factors influenced the global oil price?

Back in 2016, a glut of oil on global markets saw the price fall to around US$30 a barrel undermining the export revenue of oil producing countries such as Russia and across the Middle East, South America and Africa.

In response, the Organisation for the Petroleum Exporting Nations (OPEC) brokered a deal with other oil producing nations to cut production with the aim of restricting global supply and pumping up prices.

Since then OPEC has been surprisingly successful in keeping these nations in line, helping the oil price to rise by around 70% in just the last twelve months.

The US decision to abandon the 2015 nuclear deal with Iran and re-impose sanctions has also added to the upward pressure on global prices. The sanctions which come back into full effect later this year are expected to remove up to a million barrels of oil a day from the global market.

This has led some analysts to speculate that oil could be headed back to US$100 a barrel, and a rise of that magnitude would certainly have an impact on growth at a very sensitive time for the global economy.

What impact would higher oil prices have on the global economy?

Rising oil prices can have a significant effect on the global economy because the demand for oil in the short term is ‘price inelastic’. This is an economic term that means that an increase in price only results in a relatively small fall in demand.

The price is inelastic due to the fact that petrol is essential to fuel our cars and transport our goods. Higher petrol costs push up prices, and it’s estimated that if oil prices hit US$100 a barrel, it would add around 0.5% to global inflation.

The main concern is that higher inflation rates may lead to higher interest rates and this can may put the brakes on global economic growth.

But there may be some relief in sight. Saudi Arabia’s energy minister, Khalid Al-Falih, recently revealed that OPEC and their Russian counterparts may consider lifting restrictions to counter the impact of the US sanctions and ease supply concerns.

The good news is that over the longer term the demand for oil is becoming more price elastic. Improvements in technology are continuing to make the global economy more energy efficient. In fact, it’s estimated that it now takes half as much petroleum to generate each dollar of real GDP than it did in 1990.

However, looking ahead, it’s important to recognise that as developing economies become richer and the emerging middle classes consume more energy, the global demand for oil is likely to keep growing for some time yet.

So what do higher oil prices mean for Australia?

In the short term, higher oil prices are good news for some investors with the share prices of Australian energy companies such as Woodside and Santos rallying strongly over the last two years.

But not so good for Australian consumers already struggling with persistent low wage growth and high levels of household debt.

In the long term however, higher oil prices will accelerate the development of alternative and more sustainable sources of energy, and this will not only be beneficial for the environment but also for oil importing economies like Australia.

 

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Markets at a glance

for the month ending 30 June 2018

upArrowAustralian sharesup by 1.09%
downArrow Australian Government Bonds yielddown to 2.670%
downArrow Australian dollar down to US$0.7564
noArrow Cash ratesteady at 1.50%
upArrow International shares4 up by 0.30%

 

1 ASX 200 Accumulation Index
2 Yield on 10 year Australian Government Bonds
3 RBA cash rate
4 MSCI – World ex Australia (USD)

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