Market Views: Will crude oil soar past $80 a barrel?

After dropping to this year's low of $62.7 on February 13, the price of Brent Crude, the benchmark for global oil purchases, has increased by around 24% to $77.7 per barrel. Another widely tracked benchmark, West Texas Intermediate (WTI) price has also climbed 21% in the same time period to $71.6.

Should oil prices continue to strengthen, it could inject inflationary pressures in certain markets,especially net oil importing emerging markets.

On the other hand, energy companies and oil producers stand to benefit from the uptick in prices, as well as Asian countries that are next crude oil exporters.

We asked two wealth specialists, an equity strategist, a multi-asset expert, a global markets strategist, and an economist whether oil prices will continue to increase in 2018, and the implications for Asian financial markets and investors.

Markus Mueller, global head of CIO office

Deutsche Bank Wealth Management

The recent surge in oil prices was primarily caused by President Trump’s decision to withdraw from the Iran nuclear deal. Oil prices in the second half of this year will be largely dependent on geopolitics. If the US does implement sanctions against Iran and if the European Union follows suit, there is a possibility that oil could break $80 a barrel or even higher.  That said, if you look at the fundamentals of the oil market, the supply/demand dynamics is largely balanced. The domestic demand in EM economies remains resilient, leading to higher demand for oil.

On the other hand, US oil production is rising rapidly to cater to the demand, amid higher oil prices.  In our base case, we forecast the WTI oil price to ease from the current level of $71 a barrel to $60 a barrel in March 2019, as geopolitical risks de-escalate and US oil production catches up.

The higher oil price would be negative to Asia economies overall.  Only Malaysia is the net exporter of oil in Asia. All other Asian economies depend on oil imports to various degrees.  Higher oil price would lead to higher import costs for Asian economies. It would also result in higher inflationary pressures and affect corporate earnings. If the oil price is sustained at the current level for longer, Asia’s central banks may consider tightening their monetary policies as inflation rises. These factors would be negative to Asian equity markets.

Higher oil prices would generally benefit some upstream oil producers. On the other hand, some downstream oil producers and manufacturing companies could be negatively impacted. 

Thomas Poullaouec, head of multi-asset solutions, Asia Pacific

T. Rowe Price

Demand for oil as measured by global economic activity overshot on the upside in late 2017 and early 2018. We anticipate global economic activity to soften from prior elevated levels, which should diminish the incremental demand for oil.

Moreover, higher oil prices are acting as a tax on demand for oil with a lag. In the US, average WTI oil prices were $51 in 2017. If oil averages at $67 in 2018, that would be a 31% year-on-year increase. Strategas Research estimates that would lead to a 11% increase in US consumer spending on energy. Unfortunately, wages will not increase that fast, so consumers would have to cut their spending on other items to fund the gap. One caveat on this analysis is the tax cut and whether some of this money would be spent or saved. So far we have heard that the US consumer is more likely to save than spend this incremental money.

Finally, the other two countries which matter for oil incremental demand are India and China. In these two countries, fuel prices on a per gallon basis in local currencies are back (in the case of India) or close to (China) to the recent highs achieved in 2014 when crude oil was above $100. If these prices are sustained over a six-to-12-month period, this will likely hurt disposable income and cause a downside surprise.

In summary, we believe that these high levels of oil prices are, on one hand, creating a cap on incremental demand and on the other hand, a catalyst for ramping up future supply. This suggests to us lower oil prices based on fundamental analysis. But of course, it ignores the short-term noise which can push away prices from these fundamental drivers.

On that basis, we are underweight real asset stocks in our multi-asset portfolios. Asian economies would benefit on aggregate from lower oil prices. The more sensitive economies are China, Japan, India, South Korea. On the other hand, Malaysia is one of the few countries in Asia that benefit from higher oil prices.

David Gaud, Asia chief investment officer 

Pictet Wealth Management

We don't forecast a fixed year-end price target for oil, but on its current trend, we are constructive. A combination of two main factors are at play: the first is the synchronised solid growth around the world and with it, the high and sustained demand from China and Europe and further rising demand from the US and India as seen in the first quarter of 2018.

This favourable context is exacerbated by the better discipline on the supply side and significant cuts in capex in past years. So in terms of supply, there is a much more lean and rational context. The fact that Venezuela’s oil production continues to decline, Iran and Russia are facing sanctions, OPEC production saw cuts and the US is lacking distribution capacity is helping further.

The rise in oil price comes as a surprise to the investors who are underweight, but probably also to some governments who had not planned it in their budget. This is an inflationary element, especially for countries where the local currency has faced selling pressure versus the dollar. The picture may change rapidly and require some action from governments and local central banks.

In Asia, the Philippines, India, and Indonesia are the three countries which were already facing some difficulties about the balancing of their budgets and the control of their deficits. The oil variable is clearly a negative that may limit further the performance and any upward revision for 2018. The oil factor is introducing higher volatility and uncertainty when investing in those countries, so the expected return has to be worth the extra risk taken.

But it also opens some new avenues that have been closed for years, especially among the energy stocks which trade at deep value. It reopens, for instance, the door to the Chinese oil companies. Those giants which have been facing structural difficulties with depleting reserves do benefit from the price recovery.

Alicia Garcia Herrero, chief economist for Asia Pacific

Natixis

Our oil forecast for the year falls short of reaching $80 ($73 per barrel in 2018 and $76 in 2019) but this does not yet incorporate the US pull-out of the Iran deal. In other words, I would expect an upward revision soon which could perhaps touch $80 a barrel.

It is great news for Malaysia.  We estimate that higher oil prices basically will leave Mahathir Mohamad enough space to cut the goods and services tax as promised in his electoral campaign without hardly affecting the fiscal budget deficit, currently at -3.1%. This is, however, very bad news for India and less so, but still bad, for Indonesia. We should see a further amplification of their current account deficits.

Capital expenditure should increase in oil exporting economies or those with a relevant refinery business, such as Malaysia and Singapore for example. I think Asian investors should get longer on oil-rich countries and assets since the trend seems increasingly clear. Oil prices will not go back to $50 a barrel so the good period for India, for example, is over. It is also not positive for China, but less so, in line with Indonesia.

Kerry Craig, global market strategist

JP Morgan Asset Management

We anticipate that it is more likely the oil price (Brent crude) trades in a $65 to $75 band over the rest of the year. The oil price has been rising steadily since the middle of 2017. Much of that rise was due to better demand dynamics and the resilience of global growth as well as dampened supply from the OPEC+ agreement. Given that the oil market was moving back into balance, it suggests that any higher price moves should be short-lived.

At the very broad level, higher oil prices are a net positive for emerging markets. On the whole, they are net exporters of oil. However, for Asian markets, the picture is mixed. There would be a direct impact, given that a sustained higher price creates a headwind for large importers like China and India. Meanwhile, the removal of fuel subsidies in economies such as Malaysia and Indonesia could make households more sensitive to higher oil prices. However, this is only if the price of oil maintains at a higher level, which is not our base case.

The biggest market impact comes via rising inflation expectations and higher bond yields. Higher oil prices are a risk to headline inflation and if inflation expectations remain highly correlated with the oil price, then bond yields could take another leg higher, creating another bout of volatility in equity markets. 

Equity markets have been having to absorb what could be a peak in growth momentum with rising rates. We don’t think this is the time to abandon risk given the very healthy corporate and economic outlook. However, a greater focus on sector and company fundamentals is needed. Resource names could still be strong performers this year. Given that higher oil price mean higher input costs for many firms, in an environment where inflation and input costs are rising, investors need to focus on companies with the pricing power to pass those costs along and maintain margins.