Chief economist update: The bad oil

The International Monetary Fund (IMF) recently released its World Economic Outlook April report where it slashed its global growth projections to 3.3% this year, down from 3.5% forecast in January and from 3.7% predicted in its October 2018 outlook papers.

As a result, the IMF also estimates that crude oil prices would drop by 13.4% this year from an average price of US$68.33 per barrel in 2018 to US$59.16. This makes sense. Lower global growth translates into less demand for oil.

Note that this is based on the "simple average of prices of UK Brent, Dubai Fateh, and West Texas Intermediate crude oil."

I don't have data for Dubai Fateh but this year to date, the average price of WTI and Brent oil is US$59.94 - still within the realms of the IMF forecast.

Yet the strong uptrend in crude oil prices since the start of 2019 - Brent oil is up 40.2% to US$70.90 per barrel; WTI oil is up 40.9% to US$63.61 - may render the IMF's prediction incorrect.

This is because although global oil demand has slowed and is slowing, the production side of the supply-demand equation appears to be shrinking by more.

The Organisation of the Petroleum Exporting Countries (OPEC), Russia and other oil producers, cut output by 1.2 million barrels per day (mpd) starting 1 January 2019 that would last until the end of June this year.

In addition, the OPEC reports that US sanctions have caused Venezuelan oil production to fall by almost 500K bpd in March from February. Add to this, US sanctions against Iran (expected to be tightened further in May) and the supply disruption caused by the tensions in Libya.

But as the International Energy Agency (IEA) notes, "The oil market shows signs of tightening as we move into 2Q19, but we see mixed signals in terms of the outlook for demand and whether stock levels are yet 'normal.'"

Higher oil prices reduce household disposable income that, in turn, reduce consumer spending and by extension, economic growth.

Higher oil prices increase business input costs, reducing margins and profits that ultimately spur reductions in business investment in plant, equipment, and staff.

More worrying, higher crude oil prices lifts inflation. This could dissuade or prevent central banks from following through on their recent switch to more accommodative policies - ones that are needed to reverse the slowing global growth momentum.

At the end of the day, the IMF looks to be correct in predicting that oil prices would be lower at the end of this year compared with 2018.

Read more: IMFOPECInternational Energy AgencyInternational Monetary FundWorld Economic Outlook
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