Oil's gift to central bankers

Only one word comes to mind when the Kingdom of Saudi Arabia is mentioned, and that is oil - for it has plenty of it.

According to Investopedia, "The Kingdom of Saudi Arabia is often cited as the world's largest oil producer. The country produces 13.24% of the oil consumed in the entire world daily. Saudi Arabia has the second-largest reserves of naturally occurring oil in the world after Venezuela. It is estimated that Saudi Arabia's oil resources amount to 260 billion barrels of oil".

It's not surprising therefore that what happens in Saudi Arabia impacts on the price of oil. Saudi Arabia's crown prince Mohammed bin Salman went on a purging spree of allegedly corrupt businessmen, ministers and even royal princes on the 4th of November is what happened.

While this has no direct significance to the oil price unlike pronouncements of production increases or cuts, the political tension alone was enough to send oil prices to two year highs. The price of Brent oil surged by 3.5% to US$64.27 a barrel on the day and that of WTI oil gained 2.9% to US$57.26 - prices not seen since June 2015.

The news in the Kingdom is still developing and the latest oil price surge could be merely a knee-jerk reaction but if the oil price continues to head north, it could be just the thing that makes central banks' wishes come true. That wish of course, is for higher inflation.

And it could for oil's demand fundamentals are strengthening given the rising growth momentum in the global economy. The International Monetary Fund's (IMF) lifting of its world economic forecasts to 3.6% (from 3.5%) on 2017 and 3.7% (from 3.6%) in 2018 bear this out. This is also captured in the latest JP Morgan/IHS Markit survey indicating that the expansion in the global economy continues to accelerate. The Global Composite PMI increased to 54.0 in October from 53.9 in the previous month. While only a slight increase over the month, "The headline index has signalled growth in each of the past 61 months. Similar rates of output expansion were noted for the manufacturing and service sectors..."

On the production side, the agreed upon production cuts that was extended to expire in March 2018 from June 2017 is expected to be extended another time. Likewise, US oil rig counts have been declining. As at 3 November, the Baker and Hughes rotary oil rig count has fallen by 1.1% to 729 rigs from the previous week and by 5.1% from this year's high of 768 rigs.

A continued rise in oil prices should, in turn, lift headline inflation that could raise inflation expectations.

Core inflation would also get a lift. While the price of food and energy are factored out of the core inflation estimate, the rise or fall of oil prices have indirect impact on core consumer prices.

This is because higher oil prices raise the electricity costs of operations as well as transport costs, among others. These higher costs would eventually be passed on to consumers.

Read more: USKingdom of Saudi ArabiaBaker & HughesBrentGlobal Composite PMIInternational Monetary FundInvestopediaJP Morgan/IHS MarkitMohammed bin SalmanVenezuelaWTI
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