Quietly over the last two months the oil price has become a thing. Now it is on the cusp of becoming a problem. That matters and is weirdly not being talked about very much, at least not yet.

Now, it is true that this newsletter has been a believer that oil prices would rise for some time.

The argument was very simple:

If the US economy was going to avoid a recession then the price of oil (and other commodities) would rise.

Consensus opinion was so convinced that the US was facing a recession and would use far less, not more, oil in the second half of the year that there was a classic mis-priced opportunity. Or at least that was our assessment.

We took up this position after the regional bank failures in March and April when we, somewhat tentatively, assessed that the sky wasn't going to fall in.

In fact, it seemed as if perhaps the very opposite could occur: the US economy could accelerate further as a growing job market meant more employed Americans spending and partaking in our largely consumption based economy.

For any new subscribers you can read our old work on oil & energy here and here.

In truth, despite our conviction for much of the next few months we were pretty puzzled that the oil price stayed so cheap and the oil market remained very quiet.

The reasons for this are less important now but, as ever, timing the market is hard and the disappointment in China's terrible economic performance are both at least partly responsible.

In the end, we were probably just a bit early and that is preferable to being late!

These days, however, oil has crossed above the symbolic $90-a-barrel for some of the major crude benchmarks. Here in the US, the widely quoted West Texas Intermediate or WTI benchmark is hovering around $87-a-barrel.​

Taking a step back, global oil prices are now at a 10-month high and are not really showing signs of slowing down as some economies like the US, accelerate their consumption.

The reasons for this steady appreciation are also manifold. China's economy not totally imploding has helped to a degree. The continued and by now cliched "resilient" strength in the US economy has also assisted, no doubt.

More important still has been the fact that major oil producers have extended the cuts that they brought into effect this spring. In particular, Saudi Arabia extended their "voluntary" 1 million barrel production cut through the end of the year. They were swiftly joined by Russia which also extended its more modest 300,000 barrel cut.

This highlights the challenge for the US and the broader West if the American domestic oil industry is no longer interested, for whatever reason, in drilling for more oil. It might sound good for the environment in theory but it leaves other regimes in control of the marginal extra supply. It also gave up a significant strategic advantage. Thanks to the hard work of our energy sector, the US had a powerful edge for much of the last decade where it produced more than enough for domestic consumption and was also able to supply others.

As our rig count has fallen, so has that political leverage:

As a reminder, the rig count is the weekly number of oil rigs currently in operation in the US.

In summary, here in the US:

We are drilling less -> producing less oil domestically -> buying more oil overseas and -> selling less overseas to our closest allies.

No bueno.

What this means practically speaking is that every time you are filing your gas tank some portion of those dollars are going to end up in non-American bank accounts. Nearly all of the regimes are not ideal no matter your political outlook: Venezuela, Saudi Arabia, Russia, Iran, etc.

For every Canada there are half a dozen uncomfortable names.

That is obviously suboptimal but can't be helped now. It does focus attention on two new and newly important questions:

• Will the rising price continue?

• And, is this appreciation a problem?

On the first point we are actually not sure. It would be simple to say that, well, it is difficult to love oil at $90-a-barrel as much as you like it at $65-70 but we are open to doing exactly that.

The thinking behind this is both simple and familiar:

It is very likely that oil demand will stay strong and may even rise and supply could stay very constrained.

What does this look like?

Well, there is no reason that oil could not rise from $85-90 to $95-100-a-barrel, some of this may simply occur naturally as the US economy continues to expand and surprise to the upside.

But we are also open to the idea of a sudden and sharp leap upwards in the oil price. It wouldn't take very much at this point and the list of potential risks are long:

• A serious hurricane in the Gulf of Mexico.

• Further OPEC+ production cuts.

• Large disruptions elsewhere to global oil supply such as a refinery fire or pipeline breach.

• Surprising stimulus measures in China that could dramatically expectations around demand.

• Etc. etc.

You get the picture.

And speak of the devil....a new hurricane, Hurricane Lee, is currently barreling towards Florida and is expected to strengthen to at least a Category 4 and possibly a Category 5 storm.​

Regardless of where Lee lands, this list underlines exactly what the risk of higher oil prices could easily look like:

A sudden spike caused by an external catalyst and a very unpleasant one at that.

This is what we think could happen at some point this autumn: after months of rising prices you get a shock - to demand or supply or even both! - that causes a sudden leap in the price of energy before its eventual collapse.

On the second question, yes, it is a problem and for a few reasons.

The single biggest reason is simply that higher energy costs are a tax on the consumer.

Just about every adult American (or really anyone) understands this. What you pay at the pump or to heat your home or run your business will go up because of higher energy costs.

This will also have a follow through effect on inflation as well.

That will take some time to show up both at the pump and in the inflation data and it won't matter overly if it is just a few months of elevated energy costs but, as we have just argued above, we don't think that will be the case.

Rather we see energy costs becoming the story in the coming weeks and months. We predict that somewhere between $90 and $100 a barrel the media and online chatter will start to fixate on this problem especially as gas creeps up to being closer to $5 a gallon nationally.

That could easily start to lead to overall weaker stock markets as a good day for energy would depress the amount of money that consumers could spend on travel, retail shopping, services spending like restaurants and movie theaters or theme parks.

Lastly, as this newsletter has argued since the beginning of its publication, this is a direct transfer of our money to OPEC and their partners.

This is an unfortunate outcome and something we have worried about for years. Because our government is against permitting more exploration for oil and gas and yet the world still needs a lot of fossil fuels more and more of them are, by default, coming from the likes of Saudi Arabia and their partners in the oil cartel.

​We also worried a lot about our government drawing down the Strategic Petroleum Reserve and then, just as worrying, not filling it up rapidly when oil hit its self-imposed (and just bizarre?) price level.​

The end result is that the American emergency reserve is half empty and oil has risen again:

​

So both of these long term Pebble Themes have now combined and we could be in trouble. Even if the US economy survives there are negative consequences.

​As we have pointed out recently, the Saudis and other Arab petrostates are going to spend their windfall on trophy and investment assets around the world. Everything from soccer players to energy infrastructure and renewables megaprojects will be targeted.

Our environmental policy has funded a huge Middle Eastern bankroll and an associated spending spree. It could have been ours.....

*******

Have questions? Care to find out more? Feel free to Download our App (!!) or 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.