Can we expect oil price deflation in 2012?

The price index of energy comprises approximately 10% of the headline CPI. It is highly correlated with oil price. The surge in oil price observed since November 2011 (Figure 1) has been the most important driver of the elevated consumer price inflation.

In August 2011, we discussed the evolution of crude price and compared prices with one year spacing.  This allows foreseeing the level of crude price index needed for a given rate of price inflation. Figure 1 presents an updated version of that in the previous post with data available through February 2012. One can see that the level of crude (domestic production) index approaches the peak value observed a year ago.  

The monthly rate of inflation is an important but only a transient indicator of the overall price change. Therefore, we have calculated the annual rate from the curves in Figure 1, where red line is the original price index (black line) shifted by one year ahead. The ratio of black and red line is the rate of oil price inflation, as shown in Figure 2.  The rate of inflation is characterized by two peaks in 2008 and 2010. Obviously, the rate of inflation is defined by two factors: the current level of oil price and that one year ago. The difference between black and red line can be considered as a crude estimate of the inflation rate. When the red line is above black line, the rate of inflation is negative. Otherwise, the rate is positive.

What can we expect in the second half of 2012 with the price index of oil peaking in the middle of 2011?  Almost inevitably, the rate of (oil price) inflation will be negative during several months, say, from May to October 2012 despite oil price is high.

Figure 1. The (producer) price index of oil (domestic crude petroleum). Red line is the original price index shifted one year ahead. The ratio of black and red line is the rate of oil price inflation shown in Figure 2.   

Figure 2. The annual rate of oil price growth.