A Bank of America – Merrill Lynch report published today warns that oil’s bullish march from February could erase the embryonic signs of recovery which are filtering throughout global equity markets, and the danger barrier is less than $10 away.
“Commodity prices have rallied tremendously from their February lows, leading some to argue that rising commodity process are a sign of the incipient economic recovery,” said Francisco Blanch, commodity strategist at Merrill Lynch.
Sharp liquidity increases by OECD and emerging markets central banks are contributing to fuel a strong rebound in equity and commodity prices, but this rally comes with its own price. “A very fast increase in oil prices in the coming months could also put the embryonic recovery at risk. In OECD economies, our economists believe that $70-$80/bbl oil could start to pose a risk to the recovery, while the risks to emerging markets growth would come in at $90-$100/bbl,” explained Blanch.
However, with so much spare capacity in the energy sphere, whether oil will continue to rise, or even touch the $80/bbl mark this year is hard to predict. Petroleum inventories worldwide are high, and OPEC has plenty of spare crude production capacity and refining is no longer the bottleneck that it was.
“The recent output disruption in Nigeria – where production is reportedly down to 1.2 million b/d at present, from an average of 1.8 million b/d in the last six months – is contributing to push oil prices higher in the near term. But spare capacity still stands at 6 million b/d, and we believe key members would step in to increase output should WTI crude prices breach the $80/bbl mark in the coming months,” said Blanch.
The rally in oil and other commodities poses the question of whether further price increases could derail the expected global economic recovery. In the full report the Merrill Lynch analysts say that ample global liquidity and near-zero interest rates could indeed boost oil prices higher still, but checks and balances should prevent runaway price inflation.
“The supply/demand balance is still characterised by weak demand and large inventories. Moreover, OPEC would probably increase output if the oil price rose above $80pb too rapidly,” concludes the report.
Moderation is key
As long as oil prices did not rise significantly above US$80/bbl, incremental increases would not prevent an economic recovery in the second half of the year. Factoring in the impact on oil-backed national economies, the report says that higher oil prices would boost imports of manufactured goods by producing nations, which would provide a partial offset for global activity.
