The spectre of US$100-a-barrel oil is threatening to make an unwelcome reappearance at a crucial time in the fight against inflation.
Up until a few months ago, the energy market was an ally of sorts to policy makers. Falling oil and gas prices did much of the heavy lifting over the first half of the year in bringing inflation under control.
But since late June, the global energy market has come back to life, with crude benchmarks rising by more than 30 per cent, largely as a result of deep production cuts by Saudi Arabia and Russia. The forces lifting oil prices higher show no signs of abating.
Already, Canadian inflation readings have started moving in the wrong direction. The risk is that a big spike in gasoline prices could undermine the soft landing that central bankers are trying to finesse.
“At a time when inflation is problematic, it’s certainly not helpful,” said Doug Porter, Bank of Montreal chief economist. “It’s another pressure point for the consumer.”
We weren’t supposed to be talking about US$100 oil at this point. The consensus view going into 2023 was that economic fears and the pressure of rising interest rates would keep energy prices in check.
But demand has remained strong. The International Energy Agency is projecting that global demand this year will average about 102 million barrels of oil a day, which is higher than the 2019 peak.
“All the things associated with the pandemic, like working from home and less economic activity overall, we’ve now more than made that up in terms of demand,” said Les Stelmach, senior vice-president and portfolio manager at Franklin Templeton Canada.
Then last month, the OPEC+ bloc of countries announced it would extend voluntary production cuts through the end of the year. West Texas Intermediate then quickly traveled to a high of nearly US$94 last week. It is now trading just shy of US$90.
Somewhat mysteriously, however, gasoline prices have barely budged over that same time. Canadian drivers have so far been spared the kind of sticker shock they encountered at the pumps last year, when the national average price peaked at more than $2.10 per litre.
As of Tuesday, the average retail price for regular unleaded gasoline in Canada was $1.64 a litre, according to data from Kalibrate Technologies. That’s slightly less than gasoline cost in late June, when West Texas Intermediate (WTI) was trading at less than US$70 a barrel.
While there’s no clear explanation for the wide gap between crude oil and gasoline prices, it could partly reflect the recent decline in consumer confidence in both the U.S. and Canada.
“Most recent numbers show that gasoline demand is falling. That tells me the consumer doesn’t really know which way the economy is going,” said Roger McKnight, senior petroleum analyst at En-Pro International Inc.
Few would be surprised if the divergence quickly vanished. Higher oil prices mean additional costs for refiners, who have to pass that on to consumers to protect their profit margins.
The surge in energy prices only adds to the likelihood that central bankers will need to remain hawkish. The realization that interest rates will probably have to stay higher for longer has fuelled a selloff in both stocks and long-term bonds over the last month.
From investors to consumers to economists to central bankers, few wanted to see the potential for triple-digit oil this year. One exception, of course, is the oil-and-gas sector itself – and those holding its stocks.
Oil and gas companies have become the newest dividend champions of the TSX. Gone are the days when surging oil prices would spark a drilling boom in the oil patch.
“It used to be if a company generated $1 of cash flow, they would put $1.50 into the ground. There is a lot more discipline in the sector these days,” Mr. Stelmach said.
Canadian producers have cut costs, reduced debt and committed to returning cash to shareholders. The energy sector is expected to contribute 28 per cent of the total TSX dividend pool this year, while accounting for only an 18-per-cent weighting in the S&P/TSX Composite Index, according to a recent Scotia Capital report.
The sector can maintain those dividends and remain profitable with WTI as low as US$50 a barrel – a huge margin of safety with prices where they are now.