Energy markets remain well supplied

Contrary to what might have been expected, oil and natural gas prices have fallen since the outbreak of the crisis in the Middle East. This is even more surprising considering the deep cuts in oil production recently implemented by OPEC+ and challenges to the safe passage of commercial ships through the Red Sea due to attacks by the Yemeni Houthis.

However, the global supply of fossil fuels remains more than sufficient to satisfy demand, and this has played an important role in returning oil prices to the trading range that has prevailed since late 2022. In the US, inventories of oil and petroleum products have increased and the number of days of consumption that can be covered is at one of the highest levels seen in recent years, excluding the pandemic period (see Chart 1).

Chart 1. US commercial petroleum product stocks

Source: LSEG Data & Analytics and EFGAM calculations. Data as at 25 January 2024.

The Energy Information Administration and the International Energy Agency see ongoing excess supply of crude oil in 2024, barring new output cuts from the OPEC+ cartel (see Chart 2). 

Chart 2. Oil demand and supply trends

Source: LSEG Data & Analytics and EFGAM calculations. Data as at 25 January 2024.

Given this evidence, one could conclude that, absent the supply problems emanating from the Middle East, the prices of oil, gasoline, and diesel could have fallen more than they did. Indeed, given that in 2023 roughly 10% of the world's seaborne oil trade and 8% of global liquefied natural gas (LNG) trade passed through the Suez Canal, it is surprising that the risk premium on fossil fuel prices has not increased more in recent weeks.

Therefore, should tensions in the Middle East ease – a scenario that unfortunately does not appear likely in the near term – it would not be unexpected if the price of oil fell from current levels.

Natural gas prices have also almost completely normalised after the 2021-22 shock. In the US, the price of the Henry Hub benchmark has returned to the range between USD2 and 3 per million British thermal units that prevailed between 2014 and 2019. In Europe the price of the benchmark at the Title Transfer Facility (TTF) in Amsterdam has fallen below EUR30 per megawatt/hour, close to early 2021 levels before the start of tensions with Russia which culminated in its aggression against Ukraine.

US natural gas inventories, thanks to a record level of production, are near six-year highs for this time of year. In Europe, despite concerns about the safety of imports, natural gas stocks remain above 70% of storage capacity. The seasonal decline in stocks is proceeding at a pace compatible with normal end winter storage levels of around 50% of capacity, about 20 percentage points higher than in the 2021-22 crisis period.

About 40% of the electricity produced in the US and about 20% of that produced in Europe comes from burning natural gas. Unsurprisingly, the wholesale price of electricity is closely correlated with that of natural gas in both economies. So far, declines in the wholesale prices of natural gas and electricity have not been transferred to domestic energy prices as quickly as the increases were during the previous two years. There is therefore room for a significant decline in utility tariffs both in the US and in the eurozone (see Chart 3).¹

Chart 3. Eurozone wholesale and Harmonised Index of Consumer Prices (HICP) electricity prices

Source: LSEG Data & Analytics and EFGAM calculations. Data as at 25 January 2024.

The normalisation of energy prices, especially those for electricity, will contribute to a further moderation of inflationary pressures. Since electricity is an important input for all sectors of the economy, including services, a decline in its price will also affect core inflation, increasing central banks' scope for cutting interest rates.

If this proves to be the case, both equity and fixed income markets would benefit, while the impact on the EUR/USD exchange rate would be broadly neutral if the Federal Reserve and the European Central Bank cut rates at a similar pace.
 

¹ In the eurozone, that is true even accounting for the end of the measures adopted by governments to mitigate the impact of past price increases on households and businesses.