Warnings come almost daily that oil and liquefied natural gas supplies will remain short and prices will rise. Investors shouldn’t forget the other side of the coin: Aggressive monetary tightening is an emerging threat to demand.
The International Energy Agency’s latest oil report on Wednesday predicted that economic growth, mostly in developing markets, will create a 500,000-barrel-a-day crude deficit next year. Over the past year, recovering demand for the fuels outstripped the slow rise in production levels. There aren’t quick ways to produce more. For years producers cut back on drilling—in the U.S. to boost profits and in Europe to start decarbonizing.
Saudi Arabia and the United Arab Emirates, key members of the Organization of the Petroleum Exporting Countries, could supply more oil now but have hesitated to act decisively. The IEA forecasts that non-OPEC producers will add a little under two million barrels a day in 2022 and nearly the same again in 2023, but it says total OPEC+ production—including the cartel’s allies—could shrink, in part because of falling Russian exports. New liquefying facilities are needed to increase global LNG supplies. It all adds up to a persistent shortfall pushing benchmarks up.
But the picture could change rapidly if central bankers overshoot in their zeal to control inflation.
High prices increase producers’ profits but also squeeze citizens and create inflation that plagues central bankers. The Federal Reserve’s 0.75 percentage-point increase in its benchmark interest rate Wednesday set a combative tone in the central-bank fight against inflation. The Bank of England raised its own benchmark rate by a quarter percentage point Thursday.
In theory, central bankers only care about taming so-called core inflation—which excludes food and fuel. However, monetary policy isn’t a precise science and bankers require steely nerves to sit on the sidelines as additional fuel inflation pushes headline figures up. Given high debt levels around the world, aggressive action could kick-start recessions. If that saps enough oil and gas demand, it might stop the rally.
High fuel prices could also be undermined by users switching to alternatives or cutting back—so-called demand destruction. High prices have already forced some European factories to shut, while, for others, the costs make shifting to alternate fuels or investing in energy-saving equipment add up. Switching can also increase the energy security of oil and gas importers, an emerging priority since Russia’s invasion of Ukraine.
For consumers, gasoline prices over $5 a gallon have increased the appeal of electric vehicles. Installing high-efficiency windows, home insulation and modern heating and cooling systems pays back more quickly. Each small change only chips away at demand, but they can add up to big numbers, much like the U.S. fuel-efficiency standards for cars did after the 1970s oil crisis.
The last commodity supercycle was fueled by China’s nearly insatiable demand as it grew and built at breakneck speed, but Beijing is now targeting lower growth. Other emerging economies have significant room to develop, but won’t be helped in the short term by rising U.S. rates. Covid-19 remains a wild card that could hit the recovery, particularly as immunity from vaccines wanes.
For now the world is short of oil and LNG. Rising demand would undoubtedly push up prices further, but the continuing economic recovery needed to make that happen seems less certain than ever.
Write to Rochelle Toplensky at rochelle.toplensky@wsj.com
Copyright ©2022 Dow Jones & Company, Inc. All Rights Reserved. 87990cbe856818d5eddac44c7b1cdeb8
