While Australian motorists are already feeling the effects of rising petrol costs at the pump, analysts believe the price of crude oil may well be heading for a return to triple digits. We examine the factors that are driving the latest rally in the price of crude and discuss the implications for the ASX200.
The relationship between economic recovery and the price of oil is delicately balanced.
Oil prices will tend to increase as the world economy grows out of recession. They also have a tendency to pick up as large developing nations such as China and established industrial giants like the US continue to create demand as their jump-started economies begin to roar into action once again. For example, China’s demand for oil in January this year jumped 28% compared with the same period last year.
On the other hand, if the price of oil increases too rapidly, inflationary shockwaves may be felt throughout the economy, forcing central banks to raise interest rates, thereby dampening the recovery, reducing demand for oil and driving down prices. Thus far the strong AUD (currently north of 0.92c) has helped limit the impact of rising oil prices in Australia.
How likely are triple digit oil prices?
In answering this question, it is worth noting the recent history of crude oil prices. After the record-high of $147 a barrel in July 2008, prices fell to a low of $32 a barrel in December of the same year. By contrast, during the past eight months we have seen a fairly narrow trading range, with oil prices fluctuating between $70 and $80 a barrel.
During the first week of April however, oil has climbed to $87 a barrel, the highest level since October 2008, leading to speculation that prices are heading towards triple digits. Morgan Stanley has set $100 as an early target, while Goldman Sachs has forecast an even more bullish $110 a barrel.
The more bearish perspective is that oil prices may be pegged back by suggestions that the economic recovery is still far from a sure deal. For example, analysts point to concerns over Greek debt levels, which have so far destabilised the euro, as a sign that we are still in the early stages of a recovery. Adding to this hesitancy are fears that fundamental levels of supply and demand are still stacked against rising prices, with the OPEC oil cartel said to have excess supply of six million barrels a day.
The impact of higher oil prices on equities
Generally speaking, higher oil prices tend to hit corporate earnings by driving up costs and can therefore be expected to dent the net value of major global stock indices.
While a strong AUD obviously helps dampen the impact of rising crude prices, there is always a tipping point - where prices will start to impact on consumer spending patterns. Households have finite budgets and with the price of fuel and mortgage repayments on the rise we will see an impact on discretionary spending. At what point this occurs is unknown. That said, there will come a time when these factors will start to impact on consumer discretionary names such as JB Hi-Fi and Harvey Norman, who heavily rely upon a robust consumer.
On the flip side, the energy sector is a prominent growth sector in the Australian market, accounting for more than 7% of the ASX 200 index’s weighting and stands to benefit greatly from rising crude prices. While increasing oil prices will clearly improve producer margins and bottom line profitability, the impacts of a rising oil price are often overstated as many of Australia’s major energy projects are actually focussed on other fuel sources, such as LNG (liquefied natural gas), CSG (coal seam gas) and GTL (gas to liquid).
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Updated: 27/04/10
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