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The escalating conflict between Russia and Ukraine has already pushed oil prices to a 14-year high and the 2008 record of more than $147 per barrel doesn't look far anymore. Several market experts already see chances of the commodity surging to new all-time highs.
Bank of America's commodity research team sees oil reaching $200 if Western nations impose an embargo on Russian oil imports, while Schork Group expect it to go to $160. Russia's deputy prime minister Alexander Novak has warned that if Western countries reject Russian oil, the price would surge to more than $300 per barrel, if not more.
US oil prices have already surged 170% since the end of 2020 and a rise to $200 would mean a further increase of more than 50%. What would such a scenario mean for global markets and the economy?
An energy-price shock of such magnitude would be challenging for oil-importing advanced nations to absorb and could also push the global economy towards stagflation, generating winners and losers in financial markets.
Energy stocks and commodity-related currencies are among the most directly oil-linked assets. However, the indirect effects of $200 oil would have an influence on precious metals such as gold, which has historically outperformed during stagflationary times.
BofA sees oil at $200/bbl in the event of an oil embargo on Russia
In the case of a Russian oil embargo, Francisco Blanch, Head of Global Commodities at Bank of America, and his team of analysts believe that oil prices might double from $100/bbl to $200/bbl.
“There could be a 5 million barrel a day or larger shortfall even if there is some offset from the release of strategic reserves and some increase in OPEC exports”, BofA says.
BofA predicts that an unanticipated 1 million barrels per day supply or demand shift may result in a $20/bbl oil price change, everything else being equal.
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Where would the embargo on Russian oil hit the most?
Russia is one of the world’s biggest producers and exporters of oil products.
According to the International Energy Agency (IEA), Russia's total oil production in December 2021 was 11.3 million barrels per day (mb/d), with crude oil accounting for roughly 10 million barrels per day (mb/d), or 11% of global output. During 2021, Russian crude oil exports averaged 5 mb/d, resulting in a total exported value of $106bn.
Although China is Russia's largest single oil purchaser, absorbing 1.6 mb/d on average in 2021, a Russian oil embargo may have the greatest impact on advanced European countries.
Germany buys 2.7 million barrels of Russian oil products each day, accounting for 30% of its total oil imports. Baltic and eastern European countries show a larger share of Russian oil imports. Also, Turkey is heavily reliant on Russia's oil imports for about 20% of its needs.
Oil imported from Russia accounts for a far smaller share of overall imports in Japan and the United States (3 and 7 percent respectively).
Reliance on Russian crude's imports by OECD nations
Russian crude imports' share in OECD countries – Credit: Capital.com / Source: IEA
Oil at $200 raises the risk of a more structural inflation
Soaring oil prices have been destabilising investor-inflation expectations, pushing them to the highest levels seen in decades.
The 10-year breakeven inflation rate in the United States, which is a proxy for what market participants expect inflation to be on average over the next decade, rose to 2.8% this week, a new record high since the series began.
Meanwhile, the price of a gallon of gasoline in the United States rose close to $4, setting another record high.
With the ongoing supply disruptions in the oil market, there is a significant risk that energy price increases will continue to exert upward pressure on the overall inflation basket.
Gasoline prices and market-based inflation hit 20-year highs
The tight relationship between 10-year US Breakeven rate and US Gasoline futures – Credit: Capital.com / Source: Tradingview
Oil at $200? Stagflation may be inevitable
Oil at $200 per barrel would certainly be inflationary, but it would also have a detrimental impact on economic growth, potentially driving the global economy into stagflation.
The International Monetary Fund (IMF) has warned that the ongoing Russia-Ukraine conflict and related sanctions against Russia would have a negative effect on the global economy.
According to Bank of America estimates, a protracted period of oil prices at $100 per barrel reduces US GDP growth in the year ahead by 1% all else being equal. If oil prices reach $200 a barrel, the negative impact on economic growth in the US might be roughly 2%.
History suggests that the global economy suffers and enters into stagflation when oil prices rise wildly.
This happened between July 1973 and December 1974, when oil prices almost tripled from $3 to $11 a barrel, with the gap between the growth rate and inflation in the United States plummeting to -14%.
The same episode occurred a few years later between March 1979 and July 1980, with oil prices rising from $15 to $40.
Oil quickly doubled from $17 to $34 during the first Gulf War in the early 90s, again bringing the differential between US GDP growth and inflation into negative territory.
Wild swings in oil prices triggered past stagflation episodes
When oil prices skyrocket, the economy falls into stagflation – Credit: Capital.com / Source: Tradingview
Oil-linked winners: energy stocks and commodity currencies
The assets most directly linked to the price of oil are obviously the shares of oil companies and the major currencies of oil-exporting countries.
Higher oil prices boost the earnings of energy companies, positively affecting stock prices. Rising oil also improves the terms of trade of an oil-exporting country and causes its currency to appreciate.
The SPDR Energy Select Sector ETF (XLE), which tracks the most-capitalised energy companies traded on the New York Stock Exchange, such as Exxon Mobil (XOM) and Chevron (CVX) shows a very tight (0.91) correlation with WTI oil prices.
When the price of oil rises oil-linked currencies such as the Canadian dollar (CAD) and Norwegian krone (NOK) tend to appreciate versus oil-dependent currencies such as the euro. The EUR/CAD pair has a high and negative link with WTI, while the EUR/NOK pair holds a similar relationship with Brent.
Energy stocks (XLE ETF) and WTI relationship – Credit: Capital.com / Source: Tradingview
Canadian dollar-euro exchange rate and WTI – Credit: Capital.com / Source: TradingviewWhen oil spiked, gold outperformed the stock market
During past episodes of stagflation, oil prices spikes were associated with gold outperforming the stock market.
The weakening economic picture, along with the presence of runaway inflation, causes investors to abandon risk assets such as equities in favour of safe havens such as gold.
When oil prices surged from $15 to $40 per barrel between 1970 and 1980, the gold-to-S&P 500 ratio increased from 2.3 to approximately 6.
Oil and gold during stagflation
WTI and Gold/S&P 500 ratio were positively correlatated during the '70s stagflation – Credit: Capital.com / Source: Tradingview
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