Re: Oil/Inflation/USD-Clash of the Titans.
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Re: Oil/Inflation/USD-Clash of the Titans.
It's OPEC+ vs. the Fed. Who will win?
The Greek mythology nerd in me can’t help thinking about this old 80’s flick given today’s surprise OPEC+ cut:
OPEC+ surprised the world today with voluntary cuts totaling 1.65 mmbpd if you include Russia’s 500kbpd seasonal “cut.”
Discounting those barrels as well as the temporary Kurdish disruptions of 400kbpd last week (expected to return to the market in the next several weeks), Lakshmi at Capital One thinks the real cuts are closer to 800kbpd.
This is still a large number, and the solidarity amidst Core OPEC was unusual, especially when you consider UAE’s previous hesitancy to anger the US.
I had two initial reactions to this:
OPEC+ is seeing something nasty brewing from a demand standpoint and wanted to get ahead of it.
MbS (Mohammed bin Salman) really wanted to stick it to Biden once again after last year’s embarrassing “Fist-Bump Fiasco,” potentially setting up an Oil spike right into an election year.
I’ve been pondering this all day and am leaning mainly towards Reason 1 (although I’m sure there’s a little bit of Reason 2 mixed in), mainly because this move seems at odds with OPEC+’s more typical Long Game:
Keep prices at a “Goldilocks” level that is high enough for its members to remain very comfortable but not high enough to incentivize significant non-OPEC SUPPLY additions or longer-term behavioral changes on the DEMAND side.
This cut, while unequivocally bullish commodity prices in the short-term, is NOT great for the longer-term Supply/Demand picture because it makes the longer-term Supply Curve more ELASTIC while potentially doing the same thing to the longer-term Demand Curve.
Oil DEMAND is notoriously INELASTIC in the short-term, but if spot prices stay high for an extended period of time — ESPECIALLY AT A TIME WHEN GLOBAL TIGHTENING IS CAUSING AGGREGATE DEMAND DESTRUCTION FOR ALL GOODS AND SERVICES — behavioral changes and substitution effects can cause longer-term DEMAND ELASTICITY.
This tweet sums up the zeitgeist for the Average Joe out there (absent the joking part):
It is NOT CLEAR to me that OPEC+ has the winning hand here in the Clash of the Titans between the Central Bank for Oil versus the Central Bank for USD.
I was in the “Higher For Longer” camp even before this surprise cut, although the markets disagreed; today’s OPEC+ action is very significant, because it potentially resets the clock on the Fed’s Inflation Fight and therefore has ramifications for ALL ASSET CLASSES.
OIL started the Inflation Conflagration in 2021, which eventually spread into stickier components. If Oil is ascendant once again, it calls into question the entire imminent Fed Pivot thesis, which many asset classes are pricing in.
From my perch, Oil Inflation is of key importance because Oil is a critical factor of production for so many parts of the global economy, ranging from transportation to petrochemicals. Furthermore, it is an “OPEX COMMODITY.”
I wrote this thread back in March, 2021:
This is the first thread I wrote in late 2021 linking Oil Inflation to the rise of the USD Wrecking Ball. I invoke it once again given OPEC+'s surprise cut today because it is relevant yet again.
It will be interesting to see how the Pivot Posse reacts to this development:
This development complicates so many things. I’ve previously characterized this environment as a GEOPOLITICAL MOSH PIT, where every Central Bank will watch out for domestic interests first and foremost INCLUDING THE FED. Now that OPEC+ (the Central Bank of Oil) has entered the fray, watch out.
Given the ramifications of a severely prolonged Inflation Fight reminiscent of the stagflationary 1970’s at a time our SPR has been gutted to levels not seen since the early 1980’s, you see what I mean by this tongue-in-cheek remark. Who knows what will break in the Shadow Banking sector as collateral damage of the Clash of the Titans? Will MbS collide into MBS?
My list of worries now includes:
The Fed now has no choice but to stay tight until something truly breaks (you ain’t seen nothin’ yet).
A re-ascendant USD Wrecking Ball might ignite China’s Debt Bomb.
A DOE devoid of fossil fuel experience not to mention common sense may revive catastrophically stupid ideas again, e.g. the Export Ban. (See below)
OPEC+ going for short-term gains now may sow longer-term seeds for more Supply AND Demand ELASTICITY.
Parting thought:
Remember this tweet from beginning of 2022?
EVERY SINGLE ELEMENT IS STILL TRUE.
Re: Oil/Inflation/USD-Clash of the Titans.
Great insight and perspective, Michael. The CB needs to stay higher for longer; with that, I agree. Rather than "break" something that will force them to pivot, I trust they will do whatever possible to dismantle the castles they've built on sand slowly. So be it if that means a lost decade with high unemployment and depression-like conditions. So long as it's orderly, the Fed wins, and we get another chance at organic capitalism vs. the zero-bound financialization of fraudsters the pivot crowd is accustomed to and counting on.
It looks like the situation is working in favor of Russia and China. I think the Biden Administration must do something to reverse the trend. The United States can produce oil and natural gas, Europe and Japan can't withstand the inflationary oil and gas for any longer.