The price of oil has an impact on the price of almost everything. While oil doesn't have any direct impact core inflation numbers it does have a large indirect impact simply because energy is an input to almost every good and service in the economy.
We seem to be at a crossroads right now with some analyst believing oil is going higher and others believing the trend from here will be neural to lower.
I know next to nothing about the oil market, but here are a few things I believe are important:
- Oil demand has declined in 2022.
With few expectations almost every year has seen increased demand for oil but 2022 has been an exception in part due to China lockdowns, less office commuting, and some amount of demand destruction. We can say with certainty that demand for oil will recover at some point, but whether that will be in a month or 6 is less clear. - The US has been releasing oil for the SPR
In an attempt to keep oil prices down the US has been releasing oil from its strategic reserves, but these reserves are now running out. Releases from the strategic reserves will come to an end over the coming months and at some point the US will need to begin refilling these reverses, increasing demand. - Russia's invasion of Ukraine continues
Russia's invasion of Ukraine shows no signs of coming to an end anytime soon and by the end of 2022 Europe plans to end all imports of Russian oil. This is likely to reduce Russian oil output further tightening supply. - Secular underinvestment
Secular underinvestment and political grandstanding against oil companies has resulted in little spare capacity. To bring more capacity to the market will take time and requires an unlikely amount of political pragmatism. - Recession?
If global growth slows and the US enters recession this should cap demand near-term. However recession odds are largely tide to oil prices. If oil prices rise significantly so will recession odds, but increased recession odds will reduce the price of oil. In recent weeks the bond market and commodity market seem to be pricing in an increased risk of recession, however the stock market and stronger than expected earnings and economic data seem to be suggesting the opposite. - Oil alternatives
Investment in nuclear power, green energy sources and increased usage of EVs could offset some of the demand for oil in the West longer-term. China and Germany are also likely to turn to coal as near-term alternative to oil. However higher natural gas prices could also have the effect of increasing demand for oil as some industries seek alternative energy sources.
On the surface it seems at least for the next 12-24 months there will be an ongoing trade-off between economic growth and oil prices. If global economic growth accelerates too much oil prices are likely to move higher which could push up inflation and trigger a US recession from higher rates and higher prices. The bull case here is probably that China lockdowns continue until at least the end of the year and Europe reconsiders Russian oil sanctions while investing in domestic energy production. However this seems unlikely.
My guess is that if oil prices continue to fall we could see a second wave of inflation caused by in part by lower oil prices temporarily boosting confidence and causing the Fed to pause hikes prematurely. Then again I have no clue and I'd assuming the market knows more than me. Curious to hear what you guys think.
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