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  1. Home
  2. / Investing

How Rising Oil Prices Could Hurt Emerging Markets

Prolonged high oil prices could fire back and hurt the global economy, particularly emerging markets.
By ELIECER PALACIOS
Oct 09, 2018 | 02:57 PM EDT
Stocks quotes in this article: EEM, USO, VLO, MPC

Brent crude oil prices continue to jump beyond $80 a barrel, spurring a rally in energy stocks. But prolonged high prices could fire back and hurt the global economy, particularly emerging markets. In an era of trade sanctions and trade wars, emerging economics are subject to geopolitical shocks that could decelerate their growth.

As a macro trade, we recommend long positions in United States Oil ETF (USO) and short positions in the iShares MSCI Emerging Markets ETF (EEM)  -- likely to trade in the opposite direction to crude oil. In our view, oil would rally first and emerging markets equities will fall afterwards as weaker countries feel the impact of higher oil prices.

The market is currently focused on Iran, but little attention has been paid to Venezuelan oil production, which in our opinion merits further scrutiny. Venezuela's oil production is currently in a free-fall as the country traverses a deep economic crisis across many energy-intensive sectors. We could see it falling below 1 million barrels a day and perhaps head towards zero very soon.

Faith Birol, director of the International Energy Administration (IEA), said in a Bloomberg interview that the IEA is making a major call to OPEC producers to increase current levels of production and avoid what they call a "red zone", hurting the economy at a time when global growth in losing momentum -- particularly in emerging markets such as Venezuela. The International Monetary Fund (IMF) just released its semi-annual "World Economic Outlook" report, which says that the growth rate of the global economy in both 2018 and 2019 is expected to remain at 3.7%, a bit lower than the 3.9% forecast in April.

Emerging economics like India, Turkey and Venezuela are feeling the pressure of increased commodity prices as they deal with currency depreciation and the consequences of President Trump's trade wars. The ones on the losing end of the equation are consumers of refined products like gasoline, diesel and jet fuel, who'd have to pay more to global refiners like Valero Energy (VLO) or Marathon Petroleum (MPC) for their finished products. Both VLO and MPC shares are up 25% for the year, closely following the movements of crude oil prices. We anticipate that this trend will continue over the next six to 12 months.

Today, the major cap to crude oil prices is in the hands of the Federal Reserve, which is in charge of adjusting interest rates -- with higher rates potentially hurting stock prices. We think crude oil prices could follow suit if the stock market were to retreat due to interest rate hikes.

For now, we're buyers of crude oil towards the end of the year, with the appropriate hedge linked to emerging markets, until we see clarity on OPEC and other producing countries on their strategy to stabilize prices.

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At the time of publication Palacios had no position in the securities discussed.

TAGS: Investing

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