Some Explanation is Needed
While I don’t profess to being an expert on any one given thing, I do know a little about a lot of things. With age comes experience and I read an inordinate amount of random things. Enough so that I can carry on a passable conversation with a wide range of people. Knowing that, I still was very surprised one day when a reporter on the New York Stock Exchange floor from China asked me about the oil market. Weird, since in past conversations she asked me if I traded oil. I said “Not directly, but we do trade a lot of Exxon”. That was all I said. Next thing I know I am some sort of oil trading expert and the three Chinese networks that had representatives on the floor all asked me about oil. Every time they interviewed me.
Since I was the go to person on the floor I figured I might as well learn a little more about the oil market itself. Trading Exxon was easy, understanding oil and oil futures was not.
So, I followed the oil market for months and every time these reporters would ask me about pricing and supplies, I had an answer. Strangely, my comments were well received in China and it ended up that was all I was asked about. Stranger still, when they asked me to make a prediction of where the markets were going as far as oil, I was right more than I was wrong.
It got so intense that one day when oil was on the rise from the mid forties to around 57 dollars a barrel, some Goldman analyst predicted a return to 100 dollar a barrel oil. I went out on a limb and said that he was wrong and I would bet him that oil will trade at 35 dollars a barrel before it ever trades at 100. I bet him my salary versus his. The Chinese loved that since they love a good gambling story and they were all in. Oil reached 58 dollars a barrel and slowly walked itself back to the mid 40’s and stayed there for quite a while. I wasn’t right but he was 100% wrong.
A followup to that story: A friend of mine at Goldman knew the analyst and someone had pointed out that a guy on the floor is betting you his salary versus yours that oil will hit 35 dollars a barrel before it ever hits 100. His reply was “What a putz.”
The point of that little story is that the oil markets are probably the most easily predictable of any of the commodity markets. Short term is always a crap shoot but mid term and longer term, it is fairly easy to predict. It is probably the best example of supply and demand in investing.
Up until now.
Oil at this writing is trading at 93.60 (WTI) and if you look at global supply and demand, that is out of whack. I have a firm belief that when oil spikes in either direction, some of the blame can fall on speculation. After following the oil market for so long I tend to think that the price disparity due to speculation is around 10 to 15%. No more. There is only so much money willing to be put at risk and I have found over the years, we have tops that normally have a 10-15% pullback when the risk is taken off. Proffessional oil traders that represent various oil consumers (airlines, down the line refiners) don’t typically buy oil at these prices. They generally have contracts locked in at lower prices and wait out the spot market. So, a lot of this is speculation.
But why you ask? Why now?
Thats an interesting question. Some of the blame is being laid at the feet of Russian and it’s possible invasion of the Ukraine. The political and economic fallout is being priced into both the equity markets and the oil markets. What I don’t understand is the comments a couple of oil analyst have said about if Russia invades The Ukraine oil could possibly go up 50 to 75 cents a gallon. But why?
Russia is a very large producer of oil and taking that supply out of the equation will automatically bump prices. Uh, on paper, maybe. In reality, it shouldn’t impact prices as much as they say.
I will give you a simple reason why. OPEC has a top line number it is producing. That number is below where it has historically produced, hence some of the run up in prices. OPEC can go to its normal production levels to make up for the lost production from Russia. The OPEC nations are already drowning in cash because of this latest spike so they may not see the need to up production. Demand is high as we come out of Covid and all is right in the Middle East right now. However, OPEC ministers are not stupid and they do know that an uncontrollable rise in oil prices is not a good thing.
Allowing the demand side control prices for any length of time is dangerous. At some point that demand will cause a recession. Too much money going to oil and not enough going to consumer production.
Back to loss of Russian production. Taking 10 million barrels of oil out of supply will certainly reduce supply but you need to look deeper than that. Russia may produce 5% of the Worlds oil but only 2.9% is exported and much of those exports are under contracts that may not be subject to sanctions. Yes, it could impact oil prices short term but certainly not by 10% or more. Let’s be realistic, there are over 30 countries that export more oil than they use. If some of them have an opportunity to increase revenues for their country, I am pretty sure you will see increased supplies after a pause.
I haven’t even mentioned the United States in any of this. While during the Trump Administration, the US became a net exporter of oil. The Biden Administration pretty much put an end to that by cancelling pipelines and closing tracks of land to exploration. Under the guise of moving us faster into “The New Green Age”, the administration has decided that creating a less friendly environment for fossil fuels, it will force the country into that “Electric Age” that progressives want so badly. Several problems with that it seems. This country is nowhere near prepared for the EV age of motor transportation. We don’t produce enough energy, we don’t have the infrastructure (big and small) to do it. It’s like forcing a newborn to eat steak. His body isn’t ready for it, so why do it.
Where we stand now is that we are again beholden to forces we have no chance of controlling and even though the administration (nor the press) has said nothing about who these rising gas prices affect most, the lower middle class and the middle class.
I know I was all over the place with this Substack so I will summarize it the best I can.
We have had a major spike in oil prices and I believe as much as 15 dollars of it is speculation. Adding another 10% to the price of oil now is unlikely only because it will do more to slow growth than any Fed rate hike. OPEC producers would rather see a solid 70-75 dollars a barrel oil and 4% global growth than 125 dollar a barrel oil and a recession. That kind of bump could be a Global catastrophe. US policies have been part of the problem as well. If you look at a chart of oil prices from March of 2020 to now oil has tripled in price. It seems that is around the same time the White House started making oil production in this country the common enemy. I don’t think that was the only reason but imagine a World where the US was still a net exporter, do you think oil would trading at $93+ a barrel?