The consensus at the start of the year seemed fairly clear, with most of the investment banks expecting the barrel price of oil to move within the narrowish band of $50-65. These projections were generally supported by the following arguments:
- Saudi Arabia would continue to play the game of reducing production to boost prices ahead of the Aramco IPO expected in the next 12-18 months.
- A significant rise in the barrel price would lead to an increase in the supply of US shale oil, thereby limiting the potential for barrel price rises.
However, the barrel oil price has risen steadily since the start of the year, with the price up around 20% taking Brent beyond $77, way above the early-year forecasts. There are several reasons for this, in our view. Firstly, it is worth noting the positive upgrades to global growth since the start of the year, which will push up forecast demand for oil as a result. Secondly, US shale oil is a light-density oil, which limits the possibilities for it to be used instead of OPEC oil should supplies of the latter fall; it is also more expensive to refine, requires more investment and offers a lower yield than heavier oils. Lastly, a number of specific events have impacted oil-producing countries such as Venezuela and Angola that have reduced the supply of oil.
Will these factors disappear in the short term? We think this is unlikely, and as such, do not expect to see much of a drop in the barrel oil price over the next few months. What will be the consequences of this high oil price? The initial impact is obvious, with inflation expected to rise in the coming months, which supports our positive view on inflation breakevens. US inflation could reach 3% in July this year, for the first time since 2011. Another, less immediate consequence would be a negative impact on global growth in the longer term, i.e. the opposite of what happened after inflation nosedived in 2014-2016. However, this would take at least until 2019 to feed through.
Meanwhile, the leading macroeconomic indicators are stable, which is reassuring and lends weight to our global growth scenario of close to 4%. We are nonetheless reducing our equity exposure after a significant rise in the markets over the last six weeks. We think European yields will continue to rise and take a positive view on inflation breakevens.