Economics 101.2
If I recall correctly, the first thing they teach you in Economics, be it at the high school level or the college level, is that prices are a manifestation of the Demand Supply curve. Which is the basis of everything I talk about when it comes to markets and business in general. If there is an adequate supply and strong demand, prices will go up and vice versa. Pretty simple stuff I think.
What is still pretty simple and may be the best example of supply demand is the oil market today. As a matter of fact, it is THE key component of the oil market all the time.
Markets get skewed a bit from time to time by speculators that raise the price of future oil deliveries by increased interest in those futures contracts. The oil market can be played a bit and has been multiple times over the years with this speculation and it has, over time, cost consumers hundreds of billions of dollars because as the price rises on the futures, the present day price of oil rises as well. However, overall, prices tend to be a direct result of demand and the ability to supply.
Of all the commodity markets in the World, the oil market is the one that is prone to those speculative outbursts. It generally functions pretty well but if some large energy trading company decides to corner a piece of it, watch out.
Is that what is happening now? I don’t think so. As I have said in past posts, I believe there is a sweet spot for oil and it should be around 55-70 dollars a barrel. Thats a big spread I know but arguments can be made for pretty much any price within that range so thats why I leave it that wide open. In addition, the consumer can adjust within that range and transportation companies (who regularly trade in the energy markets) factor those prices as well. Now, what I think we are seeing is a rare instance where there is a true supply/demand disruption. Demand, even though some economies are still struggling, is higher than supply right now.
Could it be Russia taking advantage of recovering economies? Could it be OPEC production being held back? Could it be American suppliers being shut out of this boon? Probably a little bit of all three.
Let’s quickly look at all three;
The Russians are definitely monkeying around with their Natural Gas supplies to Western Europe and it’s very possible they have started to create a supply shortage as well by reducing production on several large fields. The excuse is that the pipelines going to Europe are already running at full capacity and they need to expand capacity and build more pipeline. In any event, this is going to be a serious problem for Western Europe as the Winter rolls around. Western Europe has sufficient supplies of oil but it is Natural Gas that will be a problem. This bundled problem is causing some heightened price risk in the oil markets but it is not the only reason we are seeing a spike.
OPEC has decided that they want the price of oil above 75 dollars a barrel for an extended period of time and the Russians are only too happy to oblige. Part of the thought process is that OPEC nations want to get every last dollar they can out of their reserves before the inevitable permanent drop-off of oil consumption due to alternative energy sources. Not really buying that one but it sort of makes sense considering that the World will only be driving electric cars and all the power we will ever need will come from the wind and the sun by 2035. So, OPEC only has roughly 15 years to exploit their reserves.
Lastly, and I think this might have a lot to do with this spike is that American shale deposits are sitting idle. It seems no one in this country wants to use a valuable resource to balance out these foreign price increases. Why would we? We were a net exporter of energy during the Trump administration and the price of oil was stabilized. The World lived very comfortably at 55-60 dollars a barrel. OPEC might have wanted something different but at the end of the day, everyone was profiting and consumers were having no issues with the price of gas. Then Joe Biden decides that energy is a bad thing and pipelines even worse and in the first 30 days in office shut down the construction of a single large pipeline project and that set the stage for what has happened the last six month in the oil market. Let’s not forget the 11,000 high paying jobs and the 30,000 jobs that have been indirectly affected by the shutdown. Why spend millions to extract oil when you can’t get it to a refinery cost effectively? In the name of climate change?
Getting this country weaned off of fossil fuels is going to happen, there is no doubt. Market forces tend to create revolutionary change and thats what America has done best over the last 100 years or so. Forcing change by government mandate has had more failures than successes and shutting the construction of this pipeline has sent a message that is now coming back to bite the administration in the butt. This has effectively taken a strong competitor out of the market and let other forces control pricing of a valuable commodity.
Two questions remain: How long will this go on and how high will prices go? Two years ago I would be able to say with a fair amount of certainty that the spikes we are seeing will be short lived and the supply side of the equation will meet the demand side and equilibrium will once again be met. Now, I am not sure and I apologize for beating this dead horse so much but this will become another foundational part of a longer term inflationary period. Supply chain disruptions, energy price hikes, wage increases and possible interest rate increases add more and more credence to my projection of a market pullback.