[Why&Next] International Oil Prices Shaken by Oil-Producing Countries' Production Cuts... Inflation Expected to Stay in the 3% Range Until Year-End

Chuseok, Heatwave, and Rising International Oil Prices... Inflation Concerns
Saudi Production Cuts Continue, Oil Prices Reach Year's Highest
Domestic Petroleum Prices Rise with 2-3 Week Lag
China's Economic Slowdown and US Diplomatic Efforts Pose Downside Risks

As Saudi Arabia, the world's largest oil producer, continues its production cuts and the possibility of the U.S. Federal Reserve (Fed) maintaining its benchmark interest rate grows, international oil prices have risen to their highest levels this year. A sharp increase in international oil prices is likely to negatively impact the domestic economy and consumer prices, which are currently stabilizing gradually. With rising agricultural product prices and the Chuseok holiday already putting pressure on inflation, the trend in international oil prices is emerging as a key variable for the second half of the year.

According to the New York Mercantile Exchange and the UK ICE Futures Exchange on the 5th, international oil prices have been rising sharply recently. West Texas Intermediate (WTI) crude oil prices have risen continuously since the 24th of last month, surpassing $85 per barrel, while North Sea Brent crude recently exceeded $88. Dubai crude, which serves as the benchmark for oil imported into Korea, has also approached the $90 mark, reaching $89 per barrel.

This is a very high level compared to just a few months ago. Dubai crude was around $73 to $75 per barrel in May but has steadily increased, surpassing $80 in July and recently fluctuating between $85 and $89. Generally, international oil prices exert upward pressure on domestic petroleum product prices with a lag of about 2 to 3 weeks. With international oil prices reaching their highest levels this year, domestic refining stocks have also shown strong performance.

[Image source=Reuters Yonhap News]

Saudi Production Cuts, Expectations of US Rate Freeze... Oil Prices Rise

The recent rise in oil prices is largely due to supply-side factors. Saudi Arabia and Russia, the world's first and second largest oil exporters, are deliberately reducing supply. Saudi Arabia, in particular, is very proactive in cutting production. The Organization of the Petroleum Exporting Countries Plus (OPEC+) played a leading role in cutting 2 million barrels in October last year and 1.66 million barrels in April this year, and since July, Saudi Arabia has independently implemented an additional cut of 1 million barrels per day, shocking the market.

Saudi Arabia is likely to continue production cuts as Crown Prince Mohammed bin Salman requires massive funds for the 'Vision 2030 Project.' The construction of the mega-future city Neom City, a core part of this project, is reported to cost over $500 billion. The market expects Saudi Arabia wants to maintain international oil prices at least above $80 per barrel and will continue production cuts in October to achieve this.

The Korea Financial Investment Center explained yesterday, "Saudi Arabia, which has been voluntarily cutting 1 million barrels per day in August and September, may announce an extension of the cuts," adding, "Russia is also expected to announce new oil export cut volumes this week ahead of the OPEC+ meeting in October." Russia cut 500,000 barrels in August and 300,000 barrels in September, and the market impact could increase depending on the scale of additional cuts.

Additionally, the expectation of the Fed ending its tightening policy has weakened the dollar, which also fuels the rise in oil prices. On the 1st (local time), the U.S. Department of Labor announced that the August unemployment rate rose to 3.8%, the highest in 18 months, supporting the analysis that the U.S. labor market is cooling faster than expected. If employment slows and the Fed's tightening stance weakens, the dollar tends to weaken, making oil, which is usually traded in dollars, relatively more attractive in price, increasing demand and pushing prices up.

Vehicles are lined up to refuel at the gas station in the Seoul direction of Anseong Rest Area on the Gyeongbu Expressway in Anseong-si, Gyeonggi-do. [Image source=Yonhap News]

China's Economic Slowdown is a Factor for Falling International Oil Prices

The Bank of Korea (BOK) forecasted in its revised economic outlook on the 24th of last month that Brent crude oil prices would maintain an average of around $84 per barrel in the second half of this year and the first half of next year, before falling to the $82 range in the second half of next year. This is slightly lower than the forecast made in May, and it is analyzed that China's economic slowdown influenced this. In fact, China's real estate market and consumption have recently contracted significantly, reducing global oil demand and increasing downward pressure on international oil prices over the past few months.

However, since China is currently implementing stimulus measures to revive its economy, it is uncertain whether the decline in oil prices will continue. The Chinese government is pushing strong real estate stimulus policies, such as lowering mortgage rates and offering preferential benefits on down payments and interest to first-time homebuyers. The People's Bank of China is also focusing on liquidity supply by lowering the foreign currency reserve requirement ratio for domestic financial institutions.

Oh Jeong-seok, a senior researcher at the Korea Financial Investment Center, explained in a report on the international commodity market trends in September, "Unless the China crisis materializes, international oil prices are expected to maintain a strong trend in the medium to long term due to strong demand in fuel sectors such as aviation." The BOK also stated, "From the perspective of oil demand, China's weakening recovery lowers the oil price outlook," but added, "There are many uncertainties in oil demand, so the trend in international oil prices needs to be monitored further."

Iran's potential to continue increasing production is also a factor for falling oil prices. The U.S. is trying to bring Iran, with whom it has hostile relations, into the oil export market by easing sanctions in response to Saudi Arabia's production cuts, and Iran is indeed increasing production. Given the political issues such as nuclear weapons development between the U.S. and Iran, it is difficult to predict the extent of cooperation, but it is analyzed that Iran's oil exports will increase for the time being. Yoon Yong-sik, a researcher at Hanwha Investment & Securities, said, "Iran's production, which is not subject to production cut obligations, increased to 3.15 million barrels in August, the highest level since 2018," adding, "In a situation where supply is not further reduced, the main factor driving energy price strength is demand growth due to economic recovery, which is unlikely."

On the 28th of last month, citizens visited Gyeongdong Market in Dongdaemun-gu, Seoul, to do their shopping. Photo by Jin-Hyung Kang aymsdream@

"Additional Oil Price Rise Risk is the Worst News"

If international oil prices rise further, it could negatively affect the domestic consumer price inflation rate. The BOK and the Ministry of Economy and Finance expect the consumer price inflation rate, which fell to 2.3% in July, to start rising again from August and fluctuate around 3% until the end of the year, with international oil price trends acting as a variable. The significant drop in inflation in July was largely influenced by the sharp year-on-year declines in gasoline (22.8%) and diesel (33.4%) prices due to falling oil prices.

Choo Kyung-ho, Deputy Prime Minister and Minister of Economy and Finance, told reporters before visiting Hanwha Ocean in Geoje, Gyeongnam, yesterday, "Inflation is expected to exceed 3% in August and September," explaining, "The biggest reason is the rise in international oil prices, which is being reflected significantly in domestic oil prices."

In particular, rising oil prices could influence inflation and become a factor for additional tightening by the Fed and the BOK. Park Sang-hyun, a researcher at Hi Investment & Securities, pointed out, "Concerns over Saudi Arabia's continued production cuts have diluted the inflationary pressure caused by weakening employment indicators, acting as an upward pressure on government bond yields," adding, "Although the possibility of demand slowdown in China is increasing, the risk of additional oil price rises due to supply-demand imbalance and inventory instability in the oil market is currently the worst news."

However, some analysts argue that recent international oil price increases were partly due to temporary factors such as heatwaves and hurricanes in the U.S., and prices are expected to stabilize gradually. Im Hwan-yeol, a researcher at Shinhan Investment Corp., said, "As demand gradually slows amid prolonged high interest rates, oil prices are expected to hover around $80 after temporary upward factors disappear," adding, "There is also hope for strengthened U.S. diplomatic efforts around the G20 summit."