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Increasing energy prices is pushing inflation higher

Oil like other commodities is priced higher or lower depending on the current supply and demand dynamics. Energy markets have seasonality, so weather plays an important role, and if commodities are priced in US dollars that can have a bearing on the price too. Currently, the demand for energy is being affected by the rise and fall in COVID-19 infections as demand destruction happens when travel restrictions and supply chains break down.

Weekly Commodity Analysis

In 2021, COVID-19 and its variants, as well as rising inflation which includes rising energy costs, have been the hottest economic topics. There is a strong likelihood that these hot topics will dominate most of 2022. Central banks will try to put a stop to inflation which many believe is caused by supply shocks and has nothing to do with the likes of the Fed, whereas others believe the COVID-19 emergency response stimulus money is to blame as more money is chasing fewer goods. With fears over the severity of Omicron abating, we have seen the price of energy once again rising.

According to the chart above, US Core CPI fluctuates much less than all consumer goods, and the rise in energy costs largely accounts for inflation variances. It makes sense that rising fuel and energy costs would affect all aspects of the consumer's lives. Rising energy costs impact the ability of producers of things to make a profit as they must spend more capital producing the commodity etc. Then the transportation and storage costs are all at the behest of the fluctuating energy prices.

To put more disposable income back into voters' pockets, President Biden announced at the end of November that there would be a coordinated Strategic Petroleum Reserve release from several nations including the UK, Japan, South Korea, and China. The increase in oil supply happened to coincide with the increasing Omicron concerns, which resulted in a drop-in global economic activity, which in turn dragged down energy prices more than the little % increase in global supply.

Though major energy consumers like Europe were going into lockdowns to try to curb Omicron's spread, Saudi Arabia decided to raise the price of its January 2022 Official Selling Price for the USA and Asia-bound shipment. The OSP increase affects all oil products and has likely offset the agreement of OPEC+ to increase the supply by 4000k BPD in January, which was agreed on last summer.

If the Fed tapers their emergency asset purchases this year so that they can raise their bank rates, it might not immediately have the desired effect on inflation. Quantitative Easing helps to keep short-term rates low, so by cutting QE they will lift the short-term rates. Rising rates will result in higher prices for all commodities and credit, due to the increase of future prices being priced in by producers and banks. The idea behind increasing rates is that it is supposed to encourage saving and less consumption, which then cools an economy, but the Fed, etc. would have to raise by several percentage points before savers start getting excited. In the meantime, all goods and services will be a few basis points more expensive.

The daily chart of Brent oil shows that since the start of December and the increase in Official Selling Prices by Saudi Arabia, we have seen an overall increase in the cost of energy.

As the Omicron disruptions look less severe the daily breakouts are stair-stepping the price of oil higher with $80 the most obvious target as it was the price printed before the Omicron variant sell-off. This is happening even though there were major travel disruptions across the holiday period in the USA.

The mainstream media narrative of lockdowns and restricted movement of people across many countries is keeping retail trader sentiment subdued. Though there is a slight bullish shift lately.

Global demand has been predicted to reach new highs in 2022 after the dip in seen in 2020. In 2021 it is expected that global demand will be around 100 million barrels per day. However, as seen over the holiday periods the demand can drop off very quickly if we get a repeat of the 2400 canceled flights in America due to aircrews being grounded because of the Omicron infections. The COVID-19 variants are likely to become more infectious as they mutate but with that comes less severity of illness. But the result will be more people getting ill quicker until we are at a level of natural immunity.

There is a risk that supply will increase as demand drops but if the Saudi’s were to keep mitigating potential falling prices by increasingly putting up the costs of shipping oil, there is likely to be a gradual increase in aggregate when sentiment becomes more bullish like we are seeing in the current market.

As a result of recovering demand and supply cuts by OPEC, oil prices have risen around 50% over the last year. It is possible any disruptions caused by the current COVID-19 situation have been priced in.

On January 4th, OPEC+ will meet and decide if a planned 400,000-barrel-per-day increase in February will proceed. Until then I am expecting the price of energy to keep rising much to the dismay of the central banks.

Using the Donchian channels on the intraday time frames is one way to trade the breakouts. On the m30 chart when the 20-period Donchian upper channel converges with the 50-period Donchian channel and price makes a new high, this can be a signal to buy a breakout. Risk is mitigated by placing a stop loss at the lower bounds of the channels.

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