A projected rise in oil demand and prices has opened a debate on the downside risks to global growth. Morgan Stanley’s Chief Global Economist, Chetan Ahya, says when it comes to oil, timing is everything.
The pace of the recent rise in oil prices has sparked a debate among investors on whether this poses downside risks to global growth. The answer depends on whether the rise is driven by a significant shift in demand (endogenous, or based on internal factors) or supply (exogenous, or relating to external factors).
Combining the projected rise in oil demand and prices, we calculate that the global oil burden will rise to 3.1% of global GDP in 2018 from 2.4% in 2017.
This current rise in oil prices is taking place against a backdrop where global growth has been strong and above trend for the past five quarters. As our global oil strategist Martijn Rats highlights, the uptick in demand for oil products centers on middle distillates (broadly, three products: jet fuel/kerosene, gasoil/diesel, and heating oil).
He notes that these products power heavy machinery and typically fuel industrial growth in emerging markets (EM) and international trade. Against this backdrop of stronger EM growth and rising demand for middle distillates, Martijn projects that oil prices (Brent crude) will rise gradually to US$85 a barrel by 4Q19.
One way to assess the impact of oil on the global economy is to look at the trend in the oil burden which is calculated by multiplying the volume of oil consumed by the average price of oil during that time, then dividing by nominal gross domestic product.
Combining the projected rise in oil demand and prices, we calculate that the global oil burden will rise to 3.1% of global GDP in 2018 from 2.4% in 2017. While above long-term averages (unsurprising given that global growth will remain above trend too), the oil burden is halfway between the 2004 level of 2.7% and the 2005 level of 3.5%. Coincidentally, the real oil price—as deflated by the U.S. Consumer Price Index (CPI)—also sits at mid-2005 levels.
The global economy is well positioned to absorb this moderate rise in the oil burden, as it was back then. A recovery in investment growth has been followed by an uptick in global productivity growth. On the whole, the buffer of these productivity gains should help the economy withstand the rise in input costs.
Similarly, during the 2003-07 period, strong growth in China resulted in an increase in oil demand and prices. However, as this growth was driven by strong productivity gains, macro stability indicators like inflation and current account surpluses remained in check and growth continued on an upward trajectory, virtually unperturbed by the rise in input costs.
As with much in life, there is a fine balance with respect to oil prices. When oil prices declined significantly from mid-2014 to early 2016, rather than being a boon to global growth, they had an adverse impact. The capex cycle was already weak, and the fall in oil and commodity prices caused another downtick in capex at commodity companies and in commodity export-dependent countries.
In the U.S., one reason why corporate credit spreads widened between late 2014 and 2016 was the decline in energy prices, which impacted the high yield credit space due to its sector composition. In contrast, the rise in oil and commodity prices today is leading to a recovery in pricing power for commodity companies and an improvement in terms of trade for commodity-exporting nations, thus providing support to capex in these segments.
Given that the rise in oil prices is an endogenous response to strong global growth and that the oil burden is not at onerous levels, at this juncture we are inclined to think that rising oil prices do not pose a major threat to aggregate global growth.
However, a rise in prices does result in relative winners and losers: Commodity producers and exporters should benefit at the expense of consumers and commodity importers. In this context, our equity strategists across all three regions (U.S., Europe and EM) are positive on the energy sector. In fixed income, our strategists are bearish on credit markets overall, particularly on high yield. Within EM credit, they are more cautious on the low-quality oil-importing names.