Why Oil Matters & Why It Could Do Well This Year
(Sunday update: We wrote the below before the Sunday surprise of the OPEC+ oil cartel cutting production by a shock 1.1M barrels. This only reinforces our below arguments and will lead to likely considerable anger in the White House. It also demonstrates just how little care is taken of US interests from some of the US's oldest allies)
We have made two points in passing about the price of oil and energy in recent editions.
Today, we would like to bring them back up, expand on them a bit and, above all, keep them front of mind.
As a recap:
Lower energy prices over the last 6 months have made it far easier for central bankers and consumers the world over. It gives the former wiggle room to hike interest rates less and alleviates pressure for everyone from regular consumers to Fortune 500 companies. This has been great and largely unexpected development.
Last week we argued that, if there was no more bank contagion and the fears of the credit crunch receded then suddenly the world would look remarkably better and yet we might have to accept higher inflation as the price for better financial stability over the short term.
If this was the case then we felt that energy and especially oil was well placed to do far better and was an ideal investment to cover two of the three main scenarios looking forward.
The reason? Oil was well placed to do well in a few possible scenarios moving forward. The substance known as "black gold" would do well in a high inflation, high growth world and also in a high inflation, low growth "stagflation world" because it is a real asset and would therefore keep its value in an inflationary world.
It would only do very poorly in a low growth, deflationary world. This is a possible world! But for now we think it is the least likely.
In short, oil and energy might be fair priced at $80-85 a barrel but was very attractive post-SVB at $55-60. Oil rose every day this past week so some of our thesis has already transpired but we still stand by our argument.
if growth hangs in there in the weeks and months to come then energy prices should rise further.
To this we would like to add a new angle or two. There are a few silver linings to lower oil and cheaper energy that we have not mentioned previously.
The new point:
The first, is that cheaper oil really hurts Vladimir Putin and the Russian war machine. Nothing hammers the Russian economy more than cheaper prices per barrel of its number one export.
Nothing makes us happier than thinking of the belt tightening that these price levels will be achieving in Russia as their models of projected earnings fall short.
In the first two months of this year, Russian oil and gas tax revenue, which makes up nearly half of their total budget revenue, fell by 46% year-over-year, Meanwhile state spending leapt by more than 50%.
Those two statistics underline the issue.
Each time the cost of the war rises higher, Russia needs a higher price per barrel to stay afloat. Some estimates are now that the price must be nearly $100 a barrel.
So, the cost of the war in Ukraine is going one way and their revenues in crucial hard currency are going the other. Long may it continue.
There is also an American angle here. Namely, the fact that the US has gladly stepped into Russia's shoes as global energy swing producer. The country truly become an export powerhouse in oil and oil refined products.
Just recently, the US breached the 12 million barrels per day level and has effectively become the refiner to the world and an energy superpower.
This is very wonderful. We argued several times over the history of this newspaper that it was much better to have strong oil production in democracies than authoritarian regimes as it would come out of the ground and be sold on the global market regardless.
Where that profit goes matters quite a bit. Right now, those profits are flowing to the USA which is then turning around and sending billions to Ukraine. That isn't happening from Saudi Arabia or Iran or Indonesia or Mexico or really anywhere. This is an excellent outcome.
This is inevitably leading to Europeans grumbling that the US is profiting from the Ukraine war. In a way they are, but a few things to note:
No one forced Europe to depend on Russia oil and gas for decades and not build either the infrastructure or the networks to easily switch.
The key problem for Europe is: they need to buy energy from somewhere. It could be the Middle East, it could be North Africa or increasingly it could be the US but they are dependent on energy imports and the cost of that will be determined by a global market not the US President or Congress.
Last but not least, there were other options, of course. Germany didn't have to shutter its nuclear power plants, all of Europe could have built more energy infrastructure like LNG facilities and pipelines and, most especially, the EU could have developed its own fracking industry.
It didn't do any of these things. Which is their right, of course but it was also their choice. That little bit of important information seems to get lost these days. Europe made their choices of their own free will and often bragged about how virtuous and green they were as a direct result. Not great.
And it isn't as if people didn't warn them. To the contrary, for years people across the energy complex and politicians of all stripes pointed out the risks and yet even up until early 2023 they did nothing.
Here is noted deep strategic thinker and thoughtful guy, former US President Donald F Trump, bluntly telling a German NATO delegation that they were fools to build new pipelines to Russia.
He was hardly polite or unbiased but those facts don't mean he was necessarily wrong either.
German politicians and policymakers didn't think much of President Trump but what does it say about their own quality of decision making to be proven so wrong? And it is not as if they heeded nice guy President Obama when he made similar (politer) arguments.
Regardless, flash forward less than 3 years from that NATO summit and that pipeline, Nordstream II, has been moth balled and the its cousin, Nordstream 1, was sabotaged.
So, the lesson is the same as when you are 6 years old: choices have consequences and those can be nasty.
The positive - and it is a huge success - is Europe has survived what could also have been a very nasty winter. They did so and it is a credit to them and to international coordination, the US energy and refining industries and the US government and the EU working together,
Let us keep our focus there. Stay positive!
We are often pretty critical of most of those actors and certainly of their ability to work together but we are thrilled to be proven wrong and excited about this success could signal about the future about multilateral cooperation now that we have discovered that history did not end, after all.
We won't hold our breathe but you can also file that under things we did not expect to write.
Don't get distracted by who may or may not be "winning" the short term swings. No one is losing more than Ukraine and the key is to make sure that, ultimately, in the end, the biggest loser is Vladimir Putin.
And make no mistake, there is plenty of work to do there. That is a topic for another week but for now, oil and the energy sector could be a good way to avoid caring too much about the very tiresome month-by-month "Where Is Inflation Headed" debate.
If you are not interested in that you can at least expect that gas prices and other energy costs will likely rise as we fly towards the US "driving" season in summer.
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