Will the OPEC+ Oil Production Cut Fuel Inflation?

04.05.2023 OPEC+ surprised the world over the weekend by announcing a production cut at a time when seasonal demand for fuel is expected to increase. The cartel asserted that, by May, production will be slashed by more than one million bbl/day. This is in addition to the two billion bbl/day production cut announced by the cartel last October. What are the implications for inflation?

Rolling Change in 3 Month Oil Production of OPEC and US chart

Crude prices surged predictably in response. The price of West Texas Intermediate spiked six per cent to just over $80/bbl on Monday. Analysts anticipate a 10 to 15 cent rise in pump prices in response to the move. Our crude-gasoline model suggests today’s national average price of $3.51/gallon is in line with current conditions. Pump prices averaged $3.48/gallon in early January, the last time crude traded at $80/bbl.

Crude vs Unleaded Gasoline chart

Investors worry that higher energy prices could fuel further inflation, at a time when the global economy can least afford it. We believe the cost of crude, a key input into transportation, acts more like a tax than a pricing spiral stimulant, helping the Fed do its work to slow demand. That’s because demand for fuel is largely inelastic, so higher energy prices will force consumers to reduce demand elsewhere, like travel. Travel has been one of the biggest beneficiaries of post-COVID reopening. Consumer spending on foreign travel, for example, has grown 10 times faster than overall spending since the end of 2021.  Higher energy prices will undoubtedly crimp travel demand and other discretionary spending.

Personal Consumption Expenditures Cumulative Growth since December 2021 chart

Bottom line: Energy prices, like most commodities, become victims of their own success. High prices beget weaker demand, which drives prices lower. History has shown that energy spikes often precede recessions. Going back to the mid-1970s, four of the last five recessions (not including the pandemic lockdown) were preceded by year-over-year crude oil gains of 50 per cent or more. Given the integral nature of oil on developed market economies, rising energy prices – like taxes or interest rates – tend to restrain growth rather than germinate inflation. In many respects, the energy market will be doing the central banks’ work for them.

Crude Oil YOY% and the Economy chart
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