Will 2022 be the year we are forced to live with dramatically higher energy costs and the word "Greenflation" becomes common and also politicized in the West?

Let us hope not.

The signs have been ominous to start the year:

• The price of the Brent benchmark of crude oil crossed above $85 this past Wednesday.

• The main US benchmark, West Texas Intermediate, or WTI petroleum crossed above $84.

This level is just beneath the highest price of 2021 and a shade beneath the most expensive oil going all the way back to 2014. After a few months off, the chatter about $100-a-barrel oil has resurfaced.

This fact, combined with bitter cold across much of the US, must be ensuring an unpleasant start to the year for many Americans. It has to be creating headaches in the White House and on Capitol Hill as well.

What are the reasons behind this rise? And will it continue?

The short term reason?

Demand.

As we noted last week, the fears around Omicron have not necessarily impacted how many Americans are choosing to live their lives. That and a sizable strategic shift in the US government's approach to lockdowns and Covid restrictions has meant that demand for fossil fuels has not been impacted as it might have been.

And an endemic virus and "learning to live with Covid" necessarily ensures that demand for oil will remain supported.

You don't have to take our word for it either. The OPEC oil cartel also recently decided that Omicron's impact would be limited and continued to hike their production quotas in line with previous expectations.

The long term reasons?

If an "Omi-gone" bounceback is why the price is moving right now, then what about longer term?

Fears of prolonged Omicron shutdowns and impacted economic activity recede do matter but not nearly as much as some of the far deeper and more structural drivers of the oil price.

There are three long term drivers that suggest the potential for long term price rises exist.

1. Low oil inventories.

2. Little available spare capacity to extract more fossil fuels.

3. And even less investment in ensuring future capacity.

The last point simply means that developing a gas field or finding another oil deposit takes years and billions of dollars of investment. This means that our present situation won't be easy to quickly reverse unless demand falls precipitously.

On the inventory point here are two charts to neatly illustrate the supply side of the equation:

OECD oil inventories a) continue to fall and b) are well beneath their 5 year average.

And when it comes to Europe, even while it has been an unusually warm season so far, European gas storage stocks are far ahead of their normal winter drawdown.

When it comes to spare capacity the picture is pretty similar. OPEC - the marginal swing producer - is losing capacity as the price of oil rises.

Many members of the cartel won't hate this, though it is worth pointing out that they are heavily incentivized to expand their capacity, spare or otherwise.

Add it all up and you have a recipe for very little 2022 supply, regardless of demand.

So, higher demand for the present is combining with the expectation of more throttled supply in the months and quarters ahead.

*******

Have questions? Care to find out more? Feel free to reach out at contact@pebble.finance or join our Slack community to meet more like-minded individuals and see what we are talking about today. All are welcome.