[Why&Next] International Oil Prices Shaken by Production Cuts from Oil-Producing Countries... Threatening 'Inflation and Economy' (Comprehensive)

Saudi Production Cuts Drive International Oil Prices to Soar
Small Decline on 7th, but Some Forecast $100
Higher Oil Prices Could Worsen Inflation, Current Account
Iran Production Increase, China Demand Drop Weigh on Prices

As major oil-producing countries Saudi Arabia and Russia continue to cut crude oil production, international oil prices are showing a steep upward trend. Although prices slightly fell on the 7th (local time) due to adjustment pressures following a rapid short-term surge, some predict that prices could again exceed $90 per barrel and approach $100. If international oil prices rise further, there is a high possibility of adverse effects on the domestic current account balance and consumer prices, which are gradually stabilizing. Amid sluggish exports to China and rising agricultural product prices, which already place a heavy burden on the economy and inflation, international oil prices are emerging as a key variable for economic recovery in the second half of the year.

Oil Prices Slightly Declined but Remain High

According to the New York Mercantile Exchange and the UK ICE Futures Exchange on the 8th, international oil prices slightly dropped on the 7th (local time) due to a strong dollar and weak demand outlook. West Texas Intermediate (WTI) crude oil futures closed at $86.87 per barrel, down $0.67 (-0.8%) from the previous day. This marked the first decline in 10 trading days after continuous rises since the 24th of last month. North Sea Brent crude continued its high-level rally above $90 but also slightly fell to $89.92 on the same day.

However, international oil prices remain very high compared to just a few months ago. The price of Dubai crude, which serves as the benchmark for crude oil imported into Korea, was only $73?75 per barrel in May but has steadily risen since then, surpassing $80 in July and reaching $91.69 per barrel on the 6th. Goldman Sachs recently forecasted in a report that under such conditions, oil prices could exceed $100 per barrel.

Even if international oil prices do not actually reach $100, they are likely to maintain a high level around $90 for a considerable period. Nam Aran, a researcher at Daol Investment & Securities, explained, "Historically, OPEC production cuts have continued until oil prices recover about 50% of the previous peak. Therefore, this production cut may continue until prices recover to around $95."

Generally, international oil prices exert upward pressure on domestic petroleum product prices with a lag of about 2?3 weeks. Since international oil prices have already risen to the $90 range per barrel, the burden on domestic prices for gasoline, diesel, and industrial products is expected to spread further. The Korea Development Institute (KDI) pointed out in its 'September Economic Trends' report released the day before that "rising international oil prices are expanding consumer price inflation, which may partially constrain the easing of economic downturn."

On the morning of the 7th, gasoline and diesel prices are posted at a gas station in downtown Seoul. [Image source=Yonhap News]

China's Economy: 'Slowdown vs. Recovery'...A Variable for International Oil Prices

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

However, as China is currently implementing stimulus measures to revive the economy, it is uncertain whether the downward trend 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 for 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.

China's export value released the day before was $284.87 billion, down 8.8% year-on-year, continuing the decline, but the rate of decrease narrowed compared to June (-12.4%) and July (-14.5%). Oh Jung-seok, a senior fellow at the International Finance Center, explained in a report on the September international commodity market trends, "Unless the China crisis materializes, international oil prices are expected to maintain a strong trend in the medium to long term due to robust demand in sectors such as aviation fuel."

On the 27th of last month, citizens are examining displayed items at a large supermarket in downtown Seoul. [Image source=Yonhap News]

Rising Oil Prices...Concerns Over Stagflation and Prolonged Tightening

If international oil prices rise further, they could negatively affect the domestic consumer price inflation rate. Especially since consumer price inflation rebounded to 3.4% in August due to this summer's heatwaves and heavy rains, sensitivity to oil price increases is heightened. The Bank of Korea and the Ministry of Economy and Finance expect inflation to ease after October and fluctuate around 3% until the end of the year, but international oil price trends could be a variable.

There are concerns that if inflation rises amid an ongoing economic downturn, the country could face stagflation. According to the Korea International Trade Association, a 10% increase in raw material prices, including crude oil, raises corporate production costs by an average of 0.43%, potentially leading to lower earnings. Despite declining exports, Korea has maintained a 'recession-type surplus' since May due to a larger decrease in imports, but rising oil prices could affect both export declines and import increases.

Rising oil prices could also prompt additional tightening by the Fed and the Bank of Korea. Park Sang-hyun, a researcher at Hi Investment & Securities, pointed out, "Concerns over Saudi Arabia's continued production cuts have diluted inflationary pressures caused by weakening employment indicators, leading to upward pressure on government bond yields. Although China's demand slowdown risk is increasing, supply-demand imbalances and inventory instability in the oil market pose the greatest risk of further price increases at this time."

Iran's Production Increase and U.S. Diplomatic Efforts...Factors for Oil Price Decline

However, some analysts argue that recent international oil price increases were also influenced by temporary factors such as heatwaves and U.S. hurricanes, and prices will gradually stabilize. Im Hwan-yeol, a researcher at Shinhan Investment Corp., said, "With the prolonged high-interest-rate environment, demand is gradually weakening, so after temporary upward factors disappear, oil prices are expected to hover around $80. Additionally, increased U.S. diplomatic efforts around the G20 summit are anticipated."

Iran's potential continued production increases are also a factor that could lower oil prices. The U.S. is trying to bring Iran, with whom it has hostile relations, into the oil export fold by easing sanctions in response to Saudi Arabia's production cuts, and Iran is indeed increasing production. From Saudi Arabia's perspective, if international oil prices rise excessively, other oil-producing countries may increase production or investments in renewable energy may accelerate, causing adverse effects. Therefore, some believe that prices above $100 per barrel would be difficult to accept.