Following you on twitter for a while. Really enjoy your posts/analysis: What are your thoughts re possibility that OPEC+ cuts (particularly with regard to Saudi) serve to provide cover to difficulty maintaining production at current levels? The evidence seems to point to possible terminal decline at Ghawar (if not, then why all the expensive spend on Saudi offshore?) and same with Russia: is lack of access to Western oil services expertise is having a negative effect on maintaining production in Siberia, etc? Combine all that with global natural decline rates in the neighborhood of ~5-8mmbd. Those factors could lead to Opec 'loss of control' of market, irrespective of what fed does. Plus what real ability will there be for fed to remain higher for longer in 2024 in what will be one of the more contentious presidential elections of all time?
In a nutshell, my question is, whether your thesis and charts above (which I believe articulate the short/medium term bear thesis very well) are based on historical assumptions of supply elasticity which no longer exist?
Thank you Michael. Appreciate you pointing out what so many overlook. Seems OPEC+ may have panicked a bit and / or over played their hand being caught up in the “The Fed is fukt/dollar is dead” rhetoric that has been so loud lately. It’s quite refreshing to read something, then have to reread, and then want to reread it again to digest what is being expressed.
I have thought the Fed has become a geopolitical tool in working to keep global order under US influence. As obviously those who wish to throw off the yoke are trying to use inflationary pressures to counter. Human nature exposes itself quite starkly when presented with a balance disruption. People start to become more visceral and long term strategies are sacrificed at the alter of ego fuel emotional reaction functions.
Is Jay Powell looking to emulate Nero, willing to let Rome burn, more than Volker in the face of empirical threats?
Thanks Michael, as always, for another thoughtful piece. I apologize in advance for way too many questions.
You draw your supply curves as nice straight lines, but that an oversimplification isn't it? It seems to me that's not how OPEC responds. Price has fallen, so shouldn't we should _expect_ OPEC+ to cut supply? How do you know this isn't simply real world moving down and left on the supply curve rather than a move of the actual curve?
Is your suggestion this will lead to a more supply elasticity solely because the higher prices it causes in the ST result in more investment? Do you expect the falling rig counts to rebound now? Or just fall less than they otherwise would? Is there any way to observe investment to confirm your thesis? Will tightening credit conditions offset any of this, or is FCF too robust for that to matter?
You say this reduces the chances of a "singularity event". Is that a bad thing for energy investors? Not to mention the carnage in the real economy, isn't a blow off peak in oil prices hard to monetize unless you're nimble and playing futures and have chosen the right contract(s)?
This makes sense. In mulling your ideas I was thinking about what else these conclusions might imply:
It makes sense that the supply curve becomes more elastic over the longer term, but only up to a certain point. At some level of production, say, pre-covid levels, we probably run out of spare capacity and oil prices really do begin to go up considerably.
So I think I can rephrase this part of your thesis as this: the global economy will basically "stagnate" at a lower total level of oil consumption (because of, e.g., the Fed's interest-rate-based suppression of aggregate demand), where total oil consumption will sit somewhere on the flatter (more elastic) part of the supply curve for longer.
(I do wonder if OPEC might continue to use supply cuts to set a price floor? Could they do this? The above reasoning suggests that such action would continue to "stretch" and flatten the elastic part of the supply curve, so that a bigger eventual move in oil quantity is required to reach a singularity point where price moves considerably.)
But if the global economy is stagnant at this lower-for-longer overall level of oil (energy) consumption, doesn't that also mean that economic growth is lower (maybe near zero or slightly contracting), and thus that growth-priced assets (beyond no longer benefitting from the inflating effects of QE) are also likely to deal with declining multiples since their actual outputs (which require energy!) are declining?
Which leads me back to my own investing thesis: Is owning a few long-dated CL/CB calls a reasonable hedge on both an energy crunch *and* a crash up in the prices of everything if the Fed does have to pivot?
What about the grains as a short term play? Last night I saw a Peter Zeihan video about the Russian destruction of that dam in Ukraine which he said destroyed the big reservoir which is used as the water supply for a large canal system that irrigates Ukraine's major area of agricultural production. Zeihan claims that will cause Ukraine to be a net food importer and will impact the countries in the region that rely on Ukraine for food.
I used to think a large majority of inflation was due to energy effects, but recently lots of data to refute that, which would not agree with your thesis.
Re: Oil/Inflation-Supply/Demand Curves & OPEC+'s Fantasyland.
Following you on twitter for a while. Really enjoy your posts/analysis: What are your thoughts re possibility that OPEC+ cuts (particularly with regard to Saudi) serve to provide cover to difficulty maintaining production at current levels? The evidence seems to point to possible terminal decline at Ghawar (if not, then why all the expensive spend on Saudi offshore?) and same with Russia: is lack of access to Western oil services expertise is having a negative effect on maintaining production in Siberia, etc? Combine all that with global natural decline rates in the neighborhood of ~5-8mmbd. Those factors could lead to Opec 'loss of control' of market, irrespective of what fed does. Plus what real ability will there be for fed to remain higher for longer in 2024 in what will be one of the more contentious presidential elections of all time?
In a nutshell, my question is, whether your thesis and charts above (which I believe articulate the short/medium term bear thesis very well) are based on historical assumptions of supply elasticity which no longer exist?
Thank you Michael. Appreciate you pointing out what so many overlook. Seems OPEC+ may have panicked a bit and / or over played their hand being caught up in the “The Fed is fukt/dollar is dead” rhetoric that has been so loud lately. It’s quite refreshing to read something, then have to reread, and then want to reread it again to digest what is being expressed.
I have thought the Fed has become a geopolitical tool in working to keep global order under US influence. As obviously those who wish to throw off the yoke are trying to use inflationary pressures to counter. Human nature exposes itself quite starkly when presented with a balance disruption. People start to become more visceral and long term strategies are sacrificed at the alter of ego fuel emotional reaction functions.
Is Jay Powell looking to emulate Nero, willing to let Rome burn, more than Volker in the face of empirical threats?
Excellent article. Appreciate the different perspective.
Very deep article ...makes us question what is the common word on the street....
It has not even been a month, and the Oil market has already given up the post OPEC+ gains. Talk about “premature emasculation.”
Thanks Michael, as always, for another thoughtful piece. I apologize in advance for way too many questions.
You draw your supply curves as nice straight lines, but that an oversimplification isn't it? It seems to me that's not how OPEC responds. Price has fallen, so shouldn't we should _expect_ OPEC+ to cut supply? How do you know this isn't simply real world moving down and left on the supply curve rather than a move of the actual curve?
Is your suggestion this will lead to a more supply elasticity solely because the higher prices it causes in the ST result in more investment? Do you expect the falling rig counts to rebound now? Or just fall less than they otherwise would? Is there any way to observe investment to confirm your thesis? Will tightening credit conditions offset any of this, or is FCF too robust for that to matter?
You say this reduces the chances of a "singularity event". Is that a bad thing for energy investors? Not to mention the carnage in the real economy, isn't a blow off peak in oil prices hard to monetize unless you're nimble and playing futures and have chosen the right contract(s)?
This makes sense. In mulling your ideas I was thinking about what else these conclusions might imply:
It makes sense that the supply curve becomes more elastic over the longer term, but only up to a certain point. At some level of production, say, pre-covid levels, we probably run out of spare capacity and oil prices really do begin to go up considerably.
So I think I can rephrase this part of your thesis as this: the global economy will basically "stagnate" at a lower total level of oil consumption (because of, e.g., the Fed's interest-rate-based suppression of aggregate demand), where total oil consumption will sit somewhere on the flatter (more elastic) part of the supply curve for longer.
(I do wonder if OPEC might continue to use supply cuts to set a price floor? Could they do this? The above reasoning suggests that such action would continue to "stretch" and flatten the elastic part of the supply curve, so that a bigger eventual move in oil quantity is required to reach a singularity point where price moves considerably.)
But if the global economy is stagnant at this lower-for-longer overall level of oil (energy) consumption, doesn't that also mean that economic growth is lower (maybe near zero or slightly contracting), and thus that growth-priced assets (beyond no longer benefitting from the inflating effects of QE) are also likely to deal with declining multiples since their actual outputs (which require energy!) are declining?
Which leads me back to my own investing thesis: Is owning a few long-dated CL/CB calls a reasonable hedge on both an energy crunch *and* a crash up in the prices of everything if the Fed does have to pivot?
What about the grains as a short term play? Last night I saw a Peter Zeihan video about the Russian destruction of that dam in Ukraine which he said destroyed the big reservoir which is used as the water supply for a large canal system that irrigates Ukraine's major area of agricultural production. Zeihan claims that will cause Ukraine to be a net food importer and will impact the countries in the region that rely on Ukraine for food.
I used to think a large majority of inflation was due to energy effects, but recently lots of data to refute that, which would not agree with your thesis.
Very interesting reasoning. I enjoyed reading your reasoning in this article.