Central banks around the world have tightened their monetary policies in an effort to curb inflation. Some expect that inflation has peaked and the slowdown in global markets, driven by monetary tightening, will lead to lower demand and consequently bring down oil prices.
Oil soared earlier this year, coming close to an all-time high of $147 per barrel in March after Russia's invasion of Ukraine. Since then, its value has declined by around 30 per cent. However, this may not be a reason to be too optimistic, and investors should prepare for further spikes in energy prices.
Here's why:
Global demand is currently artificially low due to Covid-19 lockdowns in China. In a way, China is providing a breather to the rest of the world. There are signs that the country might relax the lockdown, especially after the Chinese Communist Party elections in October.
Secondly, the Russia-Ukraine crisis could further escalate. It has been six months since the war began and while the markets might be getting used to it, the crisis is likely to worsen. Ukraine’s counterattacks show that it is strong and well-stocked with sophisticated ammunition.
Consequently, Europe's winter will be very tough — 40pc of its gas was supplied by Russia prior to the invasion — and inflation will become a major issue for the region. Some estimate UK's inflation will reach 18pc while its interest rates will go up to 4pc.
In addition, any accident near Ukraine's Zaporizhzhia nuclear plant could plunge the world into an even more dangerous situation.
Read: How the Russia-Ukraine war rattled global markets
Thirdly, the Taiwan situation cannot be ignored. China has reacted strongly to US House Speaker Nancy Pelosi's visit by launching military exercises near the island. This could become another tension point in world politics.
US billionaire investor Ray Dalio, who founded the world's largest hedge fund, wrote an insightful article on this risk. As Dalio explains, China’s share of global trade is seven times larger than Russia's. Half of the global container fleet passed through the Strait of Taiwan last year, according to Bloomberg.
Any disruption of sea traffic in the Taiwan Strait due to Chinese military exercises will cause a major shock to the global supply chain, which will hit the semiconductor industry the hardest. Already, two sea liners have redirected their fleet to avoid the strait. This could become the biggest disruption to the global supply chain since the pandemic's emergence.
Lastly, the United States' oil reserves are declining. The country is running on emergency reserves and it might need to replenish these by November, which could lead to a spike in oil prices.
Iran's re-entry would be the only significant addition to capacity but it may not be sufficient to deal with the other issues. As long as the Russia-Ukraine conflict and China-Taiwan tensions remain, oil prices rising to $200 a barrel cannot be ruled out. Therefore, expectations of peak inflation are premature.
