Here we go again…
The Organization of Petroleum Exporting Countries+ (or OPEC+, which also includes Russia) announced oil production cuts.
It said that it would cut its output by more than one million barrels of oil per day.
When OPEC+ cuts production, oil price goes up.
It’s simple supply-demand logic. OPEC+ cuts reduce supply while demand remains unchanged—or grows. This pushes the price of crude higher.
And that’s exactly what happened. Oil prices soared since their mid-March lows. The price of crude has been up about 13% since then.
Oil and oil products don’t only fuel cars and trucks.
They also fuel inflation.
Why would OPEC+ cut now, and what’s next?
Why Did OPEC+ Announce the Cut?
It’s simple economics. Lower supply means higher prices.
And OPEC+ wants to make more money while it can.
The world is moving away from fossil fuels and toward renewable energy.
The clock is ticking for the likes of Saudi Arabia and Russia.
In a couple of decades, it’s very likely that their vast oil reserves will be left unused.
So while the world is still buying oil, OPEC+ wants to maximize its revenue.
The International Energy Agency forecast a deficit of about one million barrels per day by the end of this year. Now OPEC+ has just doubled this deficit.
Prepare for higher prices of oil and oil products.
Higher Oil Prices Could Boost “Long Inflation”
Inflation has been running high for months now.
In February, annual inflation was 5% in the United States. It was somewhat lower than in January when it reached 5.3%.
But the rate of inflation could start rising again because of the OPEC+ move.
Oil and oil products are an important cost factor pretty much across the board.
They influence the cost of energy and transportation. Unless the production of a certain good or service is fully based on renewable energy, it will be impacted by higher oil prices.
But we are still far away from completely relying on energy derived from nuclear sources, solar, wind, or hydrogen.
A lot of the world still runs on oil. And the developing nations where most of the world’s manufacturing is concentrated are particularly dependent on “dirty” sources of energy.
As a result, inflation could rise again. In fact, it most certainly will.
What should investors do?
First, prepare for higher inflation. Broad markets have been expecting the world’s central banks to “pivot” and start lowering interest rates for a while now.
OPEC’s production cut turned the tables on these investors.
They have rotated their portfolios out of commodities, including oil, and started buying safe-haven assets like the Treasurys when the world’s markets became turbulent due to the banking crisis.
Now the reverse could happen.
A lot of investors see commodities as an inflation hedge. So when inflation goes up, they start buying commodities again.
Second, protect your portfolio. Set up stop losses and make sure that your capital is shielded from wide market swings.
Third, focus on the megatrends that will not stop regardless of where oil is headed next. Higher oil prices provide an incentive to public and private investors to accelerate the clean energy transition.
This is where we see the best opportunities today.
Thank you for your loyal readership,
The Financial Star team