With inflation surging, led by lofty oil and natural gas prices in 2021, Federal Reserve policymakers this week said they would hasten their drawdown of pandemic aid and signaled they could raise interest rates multiple times in 2022.
While the shift presents potential downsides for energy companies in the year ahead – notably, higher borrowing costs -- commodities markets responded favorably. Oil prices climbed Thursday, the first full trading session after the announcement by the Fed, as it is known. Market participants interpreted the policy change as a bullish read on the economy and energy demand, recent fears about the new variant of the coronavirus aside.
“The Fed’s confidence in the strength and sustainability of the recovery in spite of the Omicron variant came as a reassurance,” said BNP Paribas Markets’ Luigi Speranza, chief global economist.
Are Interest Rate Hikes Coming?
Fed officials last month trimmed a $120 billion bond buying program by $15 billion/month. On Wednesday, policymakers agreed to fast track the reduction to $30 billion/month and set a pace to end the program by March. Officials said they want to culminate the asset purchases and then shift to raising rates.
The Fed launched the special bond buying endeavor and lowered its benchmark short-term interest rate to near zero to stimulate the economy. It did this amid demand destruction imposed by coronavirus outbreaks and government lockdowns in 2020. A majority of Fed policymakers said this week they now favor three quarter-point rate increases next year, though Speranza and other observers don’t expect the first increase before next summer.
The U.S. economy – and activity across much of the globe – roared back in 2021. This, combined with pent-up demand and festering supply-chain challenges in the pandemic’s wake, fueled spikes in inflation. The Fed is now eager to tame those increases, even if it means slowing economic growth with higher rates.
The U.S. Bureau of Labor Statistics (BLS) said earlier this month the consumer price index jumped 6.8% in November from the same month a year earlier. That marked the fastest rate of increase since 1982 and the sixth consecutive month of inflation above 5%.
November energy prices soared 33% from a year earlier — far more than any other category tracked by the BLS — and jumped 3.5% from October, according to the federal report. Oil, natural gas and other energy commodity prices collectively climbed 5.9% month/month in November and 57.5% year/year.
The November data did not account for the emergence of the Omicron variant, which is expected to curb oil demand in the near term, according to the International Energy Agency (IEA). Still, the virus is not projected to derail momentum, with crude demand forecast by IEA to rise by 5.4 million b/d this year and another 3.3 million b/d in 2022, reaching pre-pandemic levels of 99.5 million b/d.
Morgan Stanley’s economic research team said higher rates would tap the brakes on inflation and curb energy commodity price increases. However, researchers said the U.S. and global economies are expected to continue growing at a brisk pace through 2022, driving demand for travel fuels derived from oil as well as consumption of natural gas to fuel power plants.
Recovering Supply Chains
In the United States, Morgan Stanley’s chief economist Ellen Zentner said supply chains were on the verge of recovery and capital expenditures are poised to rise across the economy, including the energy sector, propelling gross domestic product growth of nearly 5% next year.
Such growth and related energy demand are expected to support prices at historically solid levels, even as they come down from 2021 peaks. This could buoy oil and gas production next year among private operators, offsetting hesitancy from large publicly traded U.S. producers that remain conservative amid pressure from investors to focus on free cash flow.
In its December Short-Term Energy Outlook, the U.S. Energy Information Administration (EIA) forecast domestic dry natural gas production will increase from 95.1 billion Bcf/d in October 2021 to 97.5 Bcf/d by December 2022, a new record level. The previous monthly record of 97.2 Bcf/d was set in November 2019.
IEA said global oil supply could increase by as much as 6.4 million b/d next year, compared with a 1.5 million b/d rise in 2021. The United States and the Saudi-led Organization of the Petroleum Exporting Countries (OPEC) and its Russia-led allies, known collectively as OPEC-plus, are expected to drive the growth.
U.S. production for the week ended Dec. 10 held steady at a 2021 high of 11.7 million b/d, according to EIA estimates reported Wednesday. Domestic output had climbed by 100,000 b/d each of the two previous weeks. Production last week averaged 700,000 b/d higher than year-earlier levels, though it was still 1.4 million b/d below the early 2020 pinnacle, prior to the pandemic.
OPEC-plus, meanwhile, said earlier this month its members would boost production by 400,000 b/d in January, continuing a pace of monthly supply increases launched in August.
