Oil at Elevated Levels: Middle East Conflict Sustains Prices Above $100

What happened

The oil market is adjusting to reflect the full impact of an eight-month conflict in the Middle East, which has caused significant disruptions to global shipping. The expectation is that, as the situation stabilizes enough for a clearer assessment, the extent of the chaos generated in the crude oil sector will become evident. Analysts indicate that the $100 per barrel level may consolidate as a new floor for prices, signaling that oil will not get cheap anytime soon.

Why it matters

Shipping disruptions and geopolitical instability in the Middle East have a direct effect on global oil supply. Even without further escalation, the cumulative impact of eight months of conflict is already substantial and is being priced in. More expensive oil raises production and transportation costs for companies across various sectors, from manufacturing to agriculture, and can fuel global inflation. For consumers, it means higher fuel costs and, potentially, higher prices for a range of products and services. Central banks, already struggling to control inflation, may face a new challenge, which could influence their interest rate decisions.

Market impact

• Interest rates and bonds: Persistent high oil prices tend to fuel inflationary pressures. This could lead central banks to keep interest rates higher for longer or even consider further increases if inflation proves more resilient. Yields on Treasuries and other sovereign bonds may rise, reflecting expectations of higher future interest rates and an inflation risk premium.
• Dollar and exchange rates: A scenario of higher global inflation and potentially higher interest rates in developed economies, especially the US, tends to strengthen the dollar. Currencies of emerging countries, such as the real, may depreciate against the dollar, especially if they are net oil importers, as their terms of trade deteriorate.
• Equities: Companies in the energy and commodities sectors tend to benefit from higher oil prices, boosting their profits and, consequently, their stocks. On the other hand, energy-intensive sectors, such as transportation, aviation, and manufacturing, may see their margins squeezed, negatively impacting their shares. The overall impact on equities may be mixed, with a possible sector rotation.
• Commodities: Oil is a key commodity, and its elevated price tends to have a ripple effect on other commodities, especially those linked to energy or heavily dependent on transportation. Agricultural commodities, for example, may see their production and transportation costs increase.
• Brazil: As an importer of part of its oil and derivatives, Brazil may face additional inflationary pressures, especially on fuel prices. This could make the Central Bank's job of controlling inflation more difficult and may lead the Copom to be more cautious in its Selic rate cutting cycles. Petrobras, as a producer, tends to benefit from high prices, but the government may face pressure to subsidize fuels, which would impact public accounts. The Ibovespa may feel the mixed effects, with the energy sector gaining and other sectors losing.

What to watch

Investors should closely monitor the evolution of the conflict in the Middle East and any developments related to shipping routes. Reports on global oil inventories, OPEC+ production data, and energy demand in key economies such as China and the US will be crucial. Furthermore, central bank statements on inflation and their outlook for interest rates will provide important insights into the monetary policy response to this scenario.

Scenarios

Base Scenario: The conflict in the Middle East remains in a state of 'managed chaos' without significant escalation, but shipping disruptions and uncertainty sustain oil prices above $100 for an extended period. Risk Scenario: An escalation of the conflict or new severe disruptions to shipping routes could push oil prices to even higher levels, exacerbating global inflation and forcing a more aggressive stance from central banks.

Original source: MarketWatch. For information only, not investment advice.