Stagflation is a word that should strike fear into the hearts of OPEC ministers scheduled to meet in Vienna on June 3. The economic phenomena of low growth and entrenched inflation that wreaked havoc in the 1970s may be back with a vengeance.
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For OPEC and its allies led by Russia, global stagflation is very bad for business. It invariably means tepid demand for crude oil in the major industrialized nations most affected, or even worse demand destruction. Higher oil and commodity prices are classically root causes of stagflation, with supply shocks leading to further price rises, volatility, and increasing business costs in a vicious cycle.
This was the case in the 1970s when supply-side shocks caused by conflict in the Middle East and sanctions pushed up energy prices at a time when rising unemployment and sluggish economic growth triggered a crisis of confidence. The scenario sounds worryingly similar to the challenges facing the global economy today.
Former US Treasury Secretary Larry Summers is among a growing list of prominent economic thinkers to flag concerns about stagflation. "There is a real concern in much of the industrialized world, certainly it's a concern in the United States," he told the BBC Today radio program in an interview on June 1. "These kind of stagflationary risks being greater than at anytime in the last 40 years is certainly the experience of the United States and many other countries."
However, core commodity prices assessed by Platts -- part of S&P Global Commodity Insights -- suggest the worst supply-side inflationary pressure has already passed. Platts Dated Brent was assessed on May 31 at $72.885/b, down from its near-term high of $137.64/b on March 8, 2022, just weeks after Russia invaded Ukraine.
Dated Brent averaged $103/b for the remainder of 2022 following the invasion, compared with an average of $80.73/b so far in 2023. A 21% fall in average benchmark prices over the period is a poor return for a combined 3.6 million b/d of theoretical cuts that the OPEC+ coalition has rolled out over the same timeframe in a mixture of formal and voluntary supply reductions. More cuts could be coming as the alliance meets in Vienna June 3-4, with Saudi energy minister Prince Abdulaziz bin Salman having hinted that short-sellers in the market could be left "ouching."
Bad for business
In terms of inflation, oil matters. The International Monetary Fund found in research published in 2017 that a 10% increase in oil prices will lead normally to a 0.4 percentage point rise in domestic inflation, the effects of which dissipate over time. This tallies with the reality on the ground today. Global inflation now appears to have peaked as central bank monetary tightening takes affect and growth stalls.
"Arguably, the biggest concern for the commodity markets remains the status of the global and US economies," S&P Global Commodity Insights research said in early May. "Concerns regarding inflationary pressures persist, evidenced by the US Federal Reserve raising interest rates again at their most recent meeting. Cooling inflation in the US in particular has become a tricky balance of raising rates and trying to avoid further collapse of regional banks. Additionally, the risk of default by the US government in early June is making waves as well."
The latter fear was removed on May 31 when the US House of Representatives voted through a bill to stave off a debt default. But staglationary fears persist, despite oil demand holding up. S&P Global analysts expect global oil demand growth of 1.9 million b/d in 2024, with the world seen consuming 104.8 million b/d. OPEC is also optimistic about market fundamentals. The group is still counting on 2.3 million b/d of demand growth in 2023, according to the latest edition of its closely-watched Monthly Oil Market Report.
However, all of these forecasts and expectations could be dashed if the perception of stagflation beginning to grip major OECD economies solidifies. The last major stagflationary shock of the 1970s triggered mass unemployment, civil unrest and knee-jerk policies to cut energy consumption. None of these are circumstances that OPEC wants to see repeated in their major customers. That would be bad for business.