Investing.com -- Using the megaphone to the hilt on its much-ballyhooed oil production cuts, OPEC managed to deliver for July its biggest price gain in 18 months as traders fretted over the specter of squeezed crude supplies this summer.
U.S. energy demand, meanwhile, has been relatively underwhelming this month, with crude inventories showing a net gain in the first three weeks without last week’s data, which would only be available Wednesday. Yet, traders gave the benefit of the doubt to the Organization of the Petroleum Exporting Countries, on the bet that the math will ultimately work out for oil bulls.
U.S. West Texas Intermediate, or WTI, crude ended July trading at $81.80 a barrel, up $1.22, or 1.5%, on the day. For the month, WTI was higher by more than $11, or nearly 16%. The U.S. crude benchmark rose to as high as $81.72 during Monday's session, a peak not seen since April.
London-based Brent crude settled at $85.56, up 57 cents, or 0.7%, on the day. For the month, it rose nearly $11, or 14%, above June’s closing price. The global oil benchmark hit a three-month high of $85.47 during Monday’s session.
The gain for July itself was the highest for both WTI and Brent since January 2022, after a five-week rally that began just ahead of the start of this month.
“Crude prices are finishing a solid month on a high note as demand prospects remain impressive and no one doubts that OPEC+ will keep this market tight,” said Ed Moya, analyst at online trading platform OANDA."
But he also noted that with WTI trying to make a run for $85, “exhaustion might settle in until we get beyond Friday’s NFP report.”
The NFP, or non-farm payrolls, report refers to U.S. job performance in July, which the Federal Reserve is keeping a close watch to decide how to move forward with inflation.
From a four-decade high of 9% in June 2022, the Fed has managed to bring inflation, measured by the Consumer Price Index, to just 3% per annum in June this year. But the success came with a big price: the raising of interest rates by 525 basis points in just 18 months to smother the runaway inflation caused by the trillions of dollars of pandemic relief spending by the government.
To keep inflation down, the Fed needs to keep a lid on U.S. jobs and wage growth. On Friday, the central bank will see how effective its high-rate regime has been in moderating these when the jobs report for July is published. Economists are forecasting a growth of 200,000 non-farm payrolls on the average for last month versus June’s 209,000. The June figure was particularly an important one for the Fed as it came below economists’ estimates for the first time in 16 months, signaling progress in the Fed’s inflation-fighting efforts.
How well the Fed does in keeping a lid on inflation will also matter to the 13-member Saudi-led OPEC and its extended OPEC+ group that includes 10 other oil producing allies steered by Russia.
OPEC+, interestingly, will be meeting on Friday too, just ahead of the release of the U.S. jobs numbers. What really matters to the oil cartel is selling its crude at the highest possible price, under the disguised term of achieving “market balance”. Until July, that aspired price was a minimum of $80 a barrel. Now, it’s back to $100 and above — its long-term target.
But Inflation isn’t just caused by the happy spending of Americans from record jobs and wage growth. It is also egged on by higher oil prices. If the crude rally from July continues without a loss of momentum, U.S. manufacturers and service producers are likely to go back to raising the costs of goods and services in America.
It wasn't always like this. A decade ago, oil was at $100 a barrel or around there. Then U.S. inflation was at a perma low of 2% or less as service and goods producers strove to keep costs low and consumers happy. The pandemic, however, changed everything. Faced with supply disruptions and higher material costs in almost everything, U.S. businesses began charging more — and developed a liking for it when consumers paid without resistance. A new era of inflation was thus born.
Oil bulls face the challenge of U.S. inflation, China in reboot
Now, if oil goes back to $100, it will pull up inflation appreciably — not like before.
If inflation spikes again, the Fed could turn aggressive with rate hikes again. Should the central bank add another 100 basis points to rates to temper the oil rally, that wouldn’t be too good for the economy — or the oil demand that rides on U.S. growth.
Aside from the Fed, OPEC also faces another challenge in the form of softer demand for oil out of China.
Data on Monday showed that Chinese manufacturing activity shrank for a fourth straight month in July, while broader business activity also deteriorated as oil’s biggest buyer struggled with a slowing post-COVID economic recovery.
Even then, Goldman Sachs, often Wall Street’s biggest cheerleader for oil, suggested that demand for oil could have far ways to go with summer, with China readying a load of stimulus measures to reboot its economy.
“The crude demand outlook is getting a boost on soft landing hopes for the US and Europe,” said Moya of OANDA. “The ace up the sleeve of oil bulls is that the energy market is still awaiting massive stimulus from China that should boost global growth prospects.”
Those on the other side of the market will be waiting to see how all these — from the NFP report to Fed response on rates and China’s demand — do, to ascertain the right selling point for crude.