So cheaper oil has made everyone a lot happier, which is not surprising. Is it reasonable to expect the price of oil to be kept under control in this way? Maybe not. Francisco Blanch, head of global commodities and derivatives research at Bank of America Corp., said on Bloomberg TV:
“We still have China in lockdown, we have large parts of Asia in partial lockdown as well. When it comes to international travel, I think it will open up in the next six to 12 months. We are down 25% in global jet fuel demand from pre-COVID-19 levels. We could see a rebound of half a million barrels a day, maybe more, just on that front… I think going into winter, there will be demand for jet fuel, you will have demand from Europe. because of the record natural gas prices they have there. And also remember that we still have a very tight global refinancing system for a variety of reasons, so I think all of that is going to drag us back.”
These are all reasons to expect the oil price to rebound, which is why Blanch is “definitely constructive” on Brent Crude. Kristina Hooper, Invesco’s chief global market strategist, takes a similar line:
“I expect oil prices to move in a range. Yes, they have gone down. Some of this has been a bit artificial because we have released a lot of our strategic reserves. So I don’t expect that trend to continue (the downtrend). Part of this too, I must say, has been driven by weakness in China. So the trend could continue if we see continued weakness in China, although I remain more bullish on the Chinese economy. So I think it’s much more likely to anticipate oil to stay in a range. And I think that’s comfortable. I think the US economy can tolerate that. I think the stock market can tolerate it because the Fed understands that it can’t affect commodity prices. It can only affect demand. So if you’re seeing an increase in inflation coming from energy, I think it’s much less likely to act than it will on an increase in prices coming from increased aggregate demand.”
Beyond demand, there is also the issue of supply. Over time, commodity prices have tended to move in long cycles of more than a decade, with periods of rising prices punctuated by long periods when materials fall or go nowhere. It is a phenomenon known as the Kondratiev Wave in honor of the Soviet economist Nikolai Kondratiev, who was executed by Stalin.
In theory, the cycle is largely driven by the inelasticity of supply. If you want to drill for more oil or extract more metals, you need to make investments well in advance. What usually happens is that capital expenditures peak at the top of the market, creating excess supply that drives prices down. Falling prices make producers reluctant to invest again, causing capital spending to drop, meaning they can’t increase supply quickly the next time demand picks up.
If commodity prices rise again, investors could see the opportunity to invest in commodities as an offer they can’t refuse. And, more generally, all investors should be aware that much of the rally in risk assets over the past two months has been based on a drop in the price of oil. It would be a shame if it went back up.