Given the ongoing high price increases everywhere in the world, market participants implicitly seem to be betting on a recession to alleviate the inflation pain by putting a cap on energy price increases. 
As of today, recession fears seem to be understandably getting the upper hand, but the question remains: what will happen to the oil price once recession fear is totally priced in, and market participants start to realise the oil price is not driven by solely recession fears?
The effect of energy prices in the overall inflation data is large, with energy and oil prices as they are. But this will probably diminish over time because of so-called base effects inflation is generally about structural prices increases, not about the level of prices.
This realisation is relevant because we should ask ourselves how high the demand price elasticity of oil is. When we paused the global economy in March 2020 - the ultimate drop in demand - the oil price only dropped 30% or so. Indeed, since then the oil price has jumped more than 160%.
This is not solely because of cyclical developments. Structural factors and supply chain issue play an important role in defining the oil price. Last summer the IMF argued that a new oil price super cycle seemed to be in the making because of:
“Pervasive supply shortages from the lack of investment that has continued since the 2014 collapse in oil price and more recently reduced investment in shale production and demand growth triggered by a strong recovery in countries such as China, a big stimulus package in United States, and global optimism about vaccines.”
The cyclical development the IMF is talking about seem to have reversed lately, but the structural underinvestment is still present.
Where now for the oil price?
The pork cycle describes the phenomenon of cyclical fluctuations of supply and prices. Oil companies invest when prices are high and vice versa. This concept is general valid, despite the curious name, which refers to when this phenomenon was first observed in the US in 1925.
In a pork cycle, the oil sector is typified by significant lead times in supply expansion projects, causing a considerable time difference between the start of an investment and the moment oil comes to the market. The lead time in projects in the oil sector can be somewhere between 8-12 years, while the lead time with shale oil is around 1-3 years.
The oil price has risen significantly and has been hovering above the $100 per barrel mark since March this year. This should at first sight stoke new investment in the oil sector and, down the road, lower oil prices. But international oil companies are already investing less in oil exploration under pressure from changing public sentiment, especially in the West.
What this means is we have entered an oil ‘substitution phase' - a phase in which it may no longer be necessary to invest in new oil sources, because the global economy is slowly but surely moving to other energy sources. The war in Ukraine and Europe’s dependence on Russian energy is only acting as a catalyst for European sovereigns to speed up this energy transition.
On top of this ‘substitution phase’ we have the Western policy to push Russia out of the global energy market. Ousting a major supplier of oil - around 10% of global supply - will have repercussions on quantity and prices.
Both the demand and the supply curves have moved in the wrong direction, meaning less quantity for higher prices. Chinese and Indian consumption of Russian oil is taking the edge off the supply shock, but it will not totally take away the pain.
Looking ahead there seems to be an interesting setting unfolding with opposing developments. First, there is of course the possible cyclical recession in the West. This would pressure oil prices downwards, as demand would retreat.
Second you have the structural underinvestment in the oil sector partly because of the energy transition. Russia being ousted from the global economic setting by the West does also not aid the structural oil price.
Looking ahead then, oil prices will most probably not make the same jump again that they did recently, meaning that the effect of energy prices in the overall prices just will diminish. But with major structural changes in the way the pork cycle works, this does not automatically mean that oil prices will drop visibly in the future.
Serdar Kucukakin is senior sovereign research analyst at Aegon Asset Management. The views expressed above should not be taken as investment advice.