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February
07
2023

Where’s Oil Going?
James Rickards

Where are oil prices going? That’s one of the most frequently asked questions (and most difficult to answer) in markets today.

A bull case can be made on the basis of persistent inflation, shortages due in part to the war in Ukraine, the Biden administration’s war on oil and natural gas and the reopening of China after the worst of the pandemic.

A bear case can be made on the basis of recent disinflation, an emerging recession and demand destruction due to the Federal Reserve’s interest rate hikes and desire to reduce wages.

So which case will prevail in the months ahead?

The Tug-of-War in Oil Prices

First, a review of price trends over the past year: Oil (as measured by the WTI front month Nymex futures contract) hit an interim high of $123.70 per barrel on March 8, 2022, shortly after the Russian invasion of Ukraine on Feb. 24.

The price eased slightly to $95.04 on March 16 once it became clear that Russian oil exports wouldn’t immediately be cut off by sanctions. In fact, Russian exports continue to this day subject to U.S. and EU price caps and limitations on exports by tanker.

Oil hit another interim high of $122.11 per barrel on June 8. That spike coincided with the peak in U.S. inflation and the coming of the summer driving season. From there, the oil price began a relentless decline.

By Dec. 9, the price of oil had fallen to $71.02 per barrel. That’s roughly a 42% collapse from the June interim high. Today, oil is about $75.00 per barrel. That’s still higher than the December low, but still down about 35% from the June high.

While the price spikes in March and June were driven by fears of supply disruptions and the highest inflation in 40 years, the recent lows have been driven by the opposite forces.

Fear of supply shortages has been replaced by demand destruction caused by Fed rate hikes and a slowing U.S. economy. Numerous leading indicators (especially inverted yield curves in U.S. Treasury securities and Eurodollar futures) point to a recession, which may already have started.

Inflation measured by the consumer price index year-over-year has come down from 9.1% in June 2022 to 6.5% by December. That’s still a high rate, but the decline has been persistent with inflation dropping every month from June through December. Disinflation has displaced higher inflation, and there’s every reason to expect this trend to continue.

In short, supply-side disruption and inflation took the price of oil to $122.00 per barrel. Demand destruction and disinflation took it back down to $75.00 per barrel. Given that the Fed continues to raise rates, the U.S. (and global) economy continues to slow and inflation is on the run, a reasonable forecast might put oil prices at $50.00 per barrel, where they were as recently as Jan. 3, 2021.

A Recipe for Higher Prices?

Of course, forecasting is never so simple. Any downward projection has to ignore the recent rally. What’s behind that rally, and why might we expect oil prices to continue to rise?

While demand is declining because of the coming recession, it’s the case that supply is declining even faster. Unlike early 2022 when the supply disruptions were largely logistical and geopolitical, the supply problems today are fundamental.

Beginning on day one of the Biden administration, the White House took steps to destroy the U.S. hydrocarbon industry. The litany is well-known. They terminated the Keystone XL pipeline from Alberta to the United States. They banned new offshore drilling for natural gas. They halted new oil and gas exploration leases on federal land. New regulations were imposed on fracking.

In the ridiculously misnamed Inflation Reduction Act signed in 2022, the administration authorized almost $1 trillion to implement the Green New Scam including subsidies on electric vehicles (EVs), subsidies on solar panels and funding for offshore windmill farms.

These radical actions were accompanied by many state initiatives from California to New Jersey, banning sales of new internal-combustion engine (ICE) automobiles after the mid-2030s and mandating electric-powered school buses and urban transportation systems. Other nations from the Netherlands to Australia are taking similar extreme measures.

But there is no climate emergency.

Green Energy: No There There

The wind and solar alternatives to oil and gas are nonfeasible in terms of maintaining baseline power to support the grid. There is not enough lithium, nickel, cobalt, graphite and copper in the world to build more than a small fraction of the batteries needed to replace ICEs with EVs. If EVs were in wide use, the vehicle charging requirements would crash the grid.

Yet all of these green failures are still in the future. For some years to come, the Davos crowd (including White House officials) will persist in attacking oil and gas. As a result, executives of major oil exploration and production companies are slashing capital expenditures and new exploration.

Major new oil fields require 10–15 years of development through discovery, rights acquisition, environmental permitting, regulatory permitting, political liaison, infrastructure installation, connecting energy sources to power drilling and pumping operations and much more. The oil field itself might take 10 years to recover these huge capital costs before finally producing profits over the remaining 10 years of production.

What energy executive wants to commit billions of dollars of oil exploration and production costs over a 20-year horizon when politicians have vowed to eliminate the use of oil and natural gas in 10 years?

The answer is none.

Limited New Production

Energy companies will keep existing fields in production, although they are rapidly depleting. New fields are not coming onstream because of the hydrocarbon animus of the Davos crowd. Even some existing fields are being shut down because oil majors such as Chevron, Shell, Exxon Mobil and BP have curtailed operations in Russia or sold local interests to Russian buyers.

New operators lack the technical resources of the oil majors to keep production at former levels in the harsh environment of Siberia. To the extent that Russia has been able to maintain oil production, that oil is increasingly being sold to China and India, which further reduces supply to the West.

The energy bottlenecks in the U.S. are not limited to oil production. Refineries are a crucial link in the energy supply chain because they convert crude oil into distilled products such as gasoline, diesel, kerosene and jet fuel. No new refineries have been built in the U.S. since 1977. Existing refineries are aging and require extensive maintenance and repair even to maintain their current inadequate level of production.

In short, a temporary alleviation of some supply bottlenecks of a logistical type and a cooling of inflation pressures at a time of emerging recession have caused a moderation in oil prices.

The Davos Crowd Can’t Repeal the Law of Supply & Demand

Still, inflation may stabilize sooner than many expect (because of a recession). Supply chain problems will return to haunt energy markets, not because of logistics, but because of a dearth of new investment – an understandable reaction to the onslaught of anti-carbon hysteria from the White House and their European allies.

The war in Ukraine will not be over soon and the likelihood of Russian victory there portends even more stringent sanctions on Russian energy. Iran is another hotspot where acts of terrorism on Israel by Iranian proxies and Israeli retaliation against Tehran may result in further restrictions on Iranian oil exports.

The debate between lower or higher oil prices will be resolved in favor of the latter. Oil companies will prosper in this environment not because of new output or higher volumes, but because of much higher prices on existing levels of production.

The greens can’t repeal the laws of physics, and the Davos crowd can’t repeal the law of supply and demand. Oil prices are headed higher.

James G. Rickards is the editor of Strategic Intelligence. He is an American lawyer, economist, and investment banker with 35 years of experience working in capital markets on Wall Street. He was the principal negotiator of the rescue of Long-Term Capital Management L.P. (LTCM) by the U.S Federal Reserve in 1998. His clients include institutional investors and government directorates. His work is regularly featured in the Financial Times, Evening Standard, New York Times, The Telegraph, and Washington Post, and he is frequently a guest on BBC, RTE Irish National Radio, CNN, NPR, CSPAN, CNBC, Bloomberg, Fox, and The Wall Street Journal. He has contributed as an advisor on capital markets to the U.S. intelligence community, and at the Office of the Secretary of Defense in the Pentagon. Rickards is the author of The New Case for Gold (April 2016), and three New York Times best sellers, The Death of Money (2014), Currency Wars (2011), The Road to Ruin (2016) from Penguin Random House.

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