Oil Prices Approach Triple Digits
At the beginning of April the price of crude oil hit its highest level in 17 months and analysts now believe the price could well be heading for a return to triple digits. We examine the factors that are driving the latest rally in the price of crude and discuss the implications for the FTSE.
The relationship between economic recovery and the price of oil is delicately balanced.
As confidence in global economic recovery grows, the price of the world’s most important commodity tends to follow suit thanks to expectations of increased fuel demand – particularly from resource-hungry nations like the US and China.
However, rising crude oil prices could actually seriously threaten economic recovery – there are concerns that if the $100 a barrel barrier is breached in the near future inflationary shockwaves would be felt throughout the economy, forcing central banks to raise interest rates and thereby reduce demand for oil and drive down prices. This is especially true in the UK, where a weak pound is magnifying the effects of higher oil costs and could eventually force the Bank of England’s hand.
How likely are triple digit prices?
Oil prices first hit $100 a barrel in January 2008, and after a record-high of $147 a barrel in July 2008, prices fell to a low of $32 a barrel in December of the same year. By contrast, over the past eight months we have seen a fairly narrow trading range, with oil prices fluctuating between $70 and $80 a barrel.
During the first week of April oil climbed to $87 a barrel – the highest level since October 2008, leading to speculation that prices are heading towards triple digits and prompting Morgan Stanley to set $100 as an early target, while Goldman Sachs forecast an even more bullish $110 a barrel.
Yet on 16 April 2010 oil prices retreated to $83 a barrel, demonstrating just how sensitive the commodity is to international economic concerns and was the highest single day decline since early February. Prices fell sharply after the Securities and Exchange Commission (SEC) charged Goldman Sachs with fraud, which spooked stock markets and spilled over into the oil markets, and renewed fears about the eurozone’s proposed bailout plan for Greece sent the dollar higher against the euro, adding to the pressure on oil prices.
The impact on equities
Higher oil prices tend to hit corporate earnings by driving up costs and denting the net value of major stock indices. The FTSE 100 recently broke through the important 5800 barrier – a 22-month high – and may therefore be particularly susceptible to the effects of more expensive oil and ripe for a pullback. However, the FTSE 100 contains a heavyweight faction of oil majors; BP, BG Group, Royal Dutch Shell and Cairn Energy are all likely to benefit from increased oil prices. As commodities tend to rally in unison, another of the FTSE’s largest sectors, mining firms, could also benefit. Increased earnings for the likes of Rio Tinto, Xstrata and Anglo American would certainly help the FTSE to remain on an upward trajectory.
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