By Noelle Micallef
The past week has been dominated by news relating to a ban on imports of Russian fossil fuels and surging oil prices. With more than 90% of natural gas consumed in the euro area being imported, these developments are deemed to dampen economic activity and continue to worry investors.
On Monday, oil prices, namely brent crude oil, rose to its highest levels since July 2008, as indicated in the chart below. This increase was due to several factors. Over the past week, United States and European allies were looking at banning imports of Russian oil in an effort to isolate Russia from the global economy. Furthermore, there were talks to revive Iran’s 2015 nuclear deal with world powers, and the interruption of Libya’s El Feel and Sharara oilfields, which resulted in the loss of 330,000 barrels per day according to the National Oil Corporate. Over the past year alone, brent crude price increased by some 80%. Higher energy costs continue to push up consumer prices, thereby pressuring global growth.
Figure 1: European Crude Oil spot price and WTI crude oil price from 2007 to 8th March 2022. Source: Bloomberg, Curmi & Partners Ltd.
In the euro area, natural gas is the most important source of energy in the manufacturing sector and the second most important primary energy resource, after petroleum-based products[1]. Increases in oil prices accordingly raises petroleum prices, which thereafter impact both the consumption channels and the intermediate goods channel. In the former, higher energy prices increase electricity bills thereby reducing households’ real disposable income and purchasing power, inherently having an impact on private consumption. As oil and gas are used as an input in the production processes of most companies, such increase would also have an impact in the intermediate goods channel. Whilst many industrial sectors, such as mining, metal and minerals sectors, have a substantial dependence on oil, other sectors may use electricity and gas indirectly; for example, companies related to food production, textiles, machinery and equipment and also services sectors such as accommodation. Furthermore, costs are also being pushed up as wheat prices are also on the rise, as Ukraine and Russia are top global crop suppliers.
Fears of Russian aggression in Eastern Europe along with concerns about the hawkishness of the Federal Reserve (the “Fed”) has once again given rise to stagflation worries. Stagflation occurs when an economy goes through a period of high inflation and slow growth. The current geopolitical environment has increased investors’ concern relating to the Fed tightening monetary policy to control inflation. According to FedWatch, a few weeks ago investors were expecting the Fed to increase rates from 0% to 1.75% by February 2023. However, analysts have now revised expectations down to an increase of 1.5% in the same period.
Policymakers are becoming increasingly aware of the need to reform supply and distribution to shield consumers from high energy prices. As Europe seeks to reduce its reliance on Russian fossil fuels, following concerns triggered by the conflict, an extra push towards energy self-sufficiency and clean power may be triggered. EU energy commissioner, Kadri Simson, has indicated that the war has made it “painfully clear that we cannot afford to leave to any third country the power to destabilise our energy markets or influence our energy choices”. In an effort to reduce global warming, Europe has committed to decreasing greenhouse gas emission by 55% by 2030 and to reach net zero emissions by 2050. Having said this, it currently remains reliant on oil and gas, and Russia provides more than 25% of the EU’s crude oil, and nearly 40% of its gas.
Rocketing oil prices, rising unemployment and loose monetary policy led to the last major stagflation period back in the 1960s, where the core consumer price index increased to a high of 13.5% in 1980 and the Fed increased interest rates to nearly 20%. Having said this, the world is much less reliant on crude oil than it once was. Furthermore, governments and policymakers may use this opportunity to continue pushing businesses and consumers towards clean energy alternatives.
The information presented in this commentary is solely provided for informational purposes and is not to be interpreted as investment advice, or to be used or considered as an offer or a solicitation to sell/buy or subscribe for any financial instruments, nor to constitute any advice or recommendation with respect to such financial instruments. Curmi and Partners Ltd. is a member of the Malta Stock Exchange, and is licensed by the MFSA to conduct investment services business.
[1] ECB Economic Bulletin, Issue 1/2022