MONTHLY ECONOMIC NOTE APRIL 211 OCTOBER 2 Analyst: Adedayo Idowu a.idowu@vetiva.com Global Oil and Food Prices; Drivers and Dependencies Prominent Themes Oil and Food prices are likely to remain important drivers of headline inflation in 211 as we have seen in most Emerging and Frontier markets. Developed economies on the other hand, are yet to feel the full impact of this price uptrend as aggregate demand remains within band. Nonetheless, pre-emptive steps are being taken through monetary tightening to manage the gradually rising inflationary expectations and sustain credibility. For instance, the European Central Bank (ECB), despite the fragile growth in the peripheral economies recently raised rates by 25bps to 1.25%. (First hike since July, 28). Crude oil prices have moved sharply on the Middle East and North Africa tensions with fears of supply shortages sending prices to a 32 month high of $126/bbl. We however believe the concerns around the trajectory of Libyan oil production though appropriate appear overdone and, current oil prices at these levels do not reflect fundamentals. We believe as these speculative assumptions are brought home, energy prices could soon become vulnerable to correction around $1/bbl as the speculative positions gradually unwind. Supply side shortages with increasing demand continue to exert upward pressure on Food prices. Severe weather patterns over the past year have impacted supplies of key Food commodities such as Wheat, Rice and Corn amongst others. Though the role of speculation cannot be discounted, in this case, we believe demand and supply fundamentals underpin high Food prices going forward. Little attention is paid to the links between Food and Oil in economies. While point input-output estimates are not available, we extrapolate that the Food sector uses about 7% - 15% of all the energy in most industrialized economies- from the beginning to the end of the Food value chain (irrigation, transportation, storage and cooking). Higher Oil prices are likely to drive Food prices higher by increasing input and production costs which will eventually be passed on to the final consumer, with huge implications for inflation. As such, we expect an aggressive monetary tightening through 211 - especially amongst emerging economies, with developed economies adopting a more modest policy response. Fig 1: Headline Inflation in Select Countries (%) Fig 2: Food Component of CPI; Select Countries (%) 2 16 18 14 Nigeria Egypt 42.6 5.7 12 8 4 Pre-dominantly higher inflation in frontier markets, while gradually climbing higher in the developed markets 1 6 Kenya China S/Africa US 16.8 13.74 36.4 3. 21 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec 211 Jan China US Eurozone Nigeria Feb 2 UK Germany 11.82 8.99 1 2 3 4 5 6 Source: Various Statistical Bulletins, Vetiva Research Source: Various Statistical Bulletins, Vetiva Research Please see last page for important disclosures Monthly Economic Note 12 April 211 I Pg. 1
Do Crude Oil Prices Reflect the Fundamentals? The 211 forecast on oil consumption had been upbeat, supported by rising demand from the emerging markets, mainly China and the Middle East, and the depletion of crude oil stock piles. This forecast was based on analysis from the Energy Information Administration (EIA) stating that Global Crude Oil consumption grew at its second-fastest pace in over three decades in 21, rising 2.8% to 86.7 million barrels per day (mbpd) surpassing the 28 levels of 86.3mbpd. Ideally, forecasted global demand in 211 of 87.9mbd is not expected to put a strain on global supply. To be specific, annual production from both OPEC and Non OPEC countries is estimated to be around 87.4mbd with a spare capacity of 4mbpd, which is sufficient to accommodate production gaps from Libya. Fig 3: Crude Oil Production in select MENA Countries 12% 5% 3% 2% World 21 crude production: 86.29mmb/d MENA 21 crude production: 3.24mmb/d MENA share of world 21 crude production: 35% 79% Saudi Arabia Iran Algeria Libya Rest of the World Source: Energy Information Administration (EIA), Vetiva Research The concerns around the trajectory of Libyan oil production, though appropriate, appear overdone. Estimates of current shut in production vary from a low of 5, barrels/day (b/d) to over 1 mbpd, from a total production of 1.8 mbpd. However, we note that Libya s production is c.5% of MENA oil production and c.2% of global oil production, which is not a deal breaker. Whilst we understand the quality of Libya s light sweet crude makes it attractive to select European buyers, we note there are alternatives in Nigeria s Bonny Light and Algeria s Saharan Blend. Moreso, Saudi Arabia, the UAE and Qatar have increased supply in the recent quarter; with spare capacity to increase production further if need be. Clearly, current oil prices at these levels do not reflect fundamentals. Overall, we think Analysts projections of c.$15/barrel (the tip off before last recession) may not be feasible. Please see last page for important disclosures Monthly Economic Note 12 April 211 I Pg. 2
Jan-9 Dec-9 Nov-91 Oct-92 Sep-93 Aug-94 Jul-95 Jun-96 May-97 Apr-98 Mar-99 Feb- Jan-1 Dec-1 Nov-2 Oct-3 Sep-4 Aug-5 Jul-6 Jun-7 May-8 Apr-9 Mar-1 Feb-11 May-87 Jun-88 Jun-89 Jul-9 Jul-91 Aug-92 Aug-93 Aug-94 Sep-95 Sep-96 Oct-97 Oct-98 Nov-99 Nov- Dec-1 Dec-2 Jan-4 Jan-5 Feb-6 Feb-7 Mar-8 Mar-9 Apr-1 Apr-11 An Oil price correction, how soon? In our opinion, if the MENA crisis does not escalate to major producers such as Saudi Arabia (low probability), energy prices could soon be vulnerable to correction as the speculative positions unwind. In the short term, China s monetary tightening, earthquake in Japan (second largest oil importer in Asia), and the recent interest rate hike in Europe all point to waning demand. In the medium term, the possibility of a Libyan ceasefire is likely to offset some of the speculation in the market, and as such, we see the possibility of a correction to $1/barrel levels. The fact is that global output growth, remains fragile, and in fact slower than expected; albeit, sentiments favour the spike. Fig 4: Crude Oil Spikes: Fundamentals or Demand/Supply Concerns ($/barrel) 15 12 9 6 3 Source: Energy Information Administration (EIA), Vetiva Research Bringing Food Prices back to the fore Food prices which have been higher than their 28 peak took a breather in March after reaching a record high in February. Is this the beginning of a correction? In this case, though the role of speculation cannot be discounted, we believe demand and supply fundamentals underpin high food prices going forward. Fig 5: Spikes in the Global Food Price Index (Points) 25 2 15 1 5 Beginning of another reversal? Source: Food and Agricultural Organization (FAO), Vetiva Research Please see last page for important disclosures Monthly Economic Note 12 April 211 I Pg. 3
Increasing demand on the back of a rapid economic growth in Emerging markets, especially Asia, and the increasing use of Food in the production of Biofuels, supply shocks as an aftermath of volatile weather patterns and trade policies thereafter, have continued to exacerbate price instability and price increases in the global market. March stands out as an outlier from the trend which is explainable given that Japan, (Largest importer of corn and Asia s largest importer of Wheat) had to grapple with a national crisis which temporarily affected demand. We expect that demand will normalize this month, and the upward trajectory of food prices to continue as people are likely to pay significantly more for Food as opposed to eating less. The Food and Oil Nexus Little attention is paid to the links between Food and Oil in economies which is apparently very strong. While point input-output estimates are not available, we extrapolate the Food sector uses about 7% - 15% of all the energy in most economies: from the beginning to the end of the Food value chain (irrigation, transportation, storage and cooking). This nexus makes the levels of Crude Oil an important factor in the production and distribution of Food. Higher oil prices are likely to drive Food prices higher by increasing the cost of input and production costs which will eventually be passed on to the final consumer. Furthermore, the increasing use of crops to produce biofuels has created an alternative use for Food. Consequently, an increase in the price of Oil leads to an increase in the demand for biofuels, and ultimately Food crops. The outlook for Food prices seems mixed, with the certainty of elevated prices in the short term, while the long term direction remains unclear. We however need to monitor the following: Climatic Changes Growth Scenarios for the economies currently driving demand, especially the emerging economies Oil price outlook (How far north?) Protectionism tendencies And black swan events not included here. Vetiva Capital Research is available via the following platforms: Bloomberg: VCML <GO> Capital IQ: www.capitaliq.com Thomas Reuters: thomsonreuters.com/financial Factset: www.factset.com Please see last page for important disclosures Monthly Economic Note 12 April 211 I Pg. 4
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