More fuel to drive oil prices higher
And another step on the yellow brick road to de-dollarisation
Of all the financial subjects I cover, I will always get the most hits writing about the housing market.
If I write about oil, however, few seem to care.
Unless, that is, you frame oil around Net Zero or geopolitics, then readership goes up. That way you are giving the subject a spicy political angle, which readers, in these polarised times, are attracted to.
There is one subject even less popular than oil: natural gas.
I don’t cover coal very often, though I imagine it would be down there in the dirt, forgive the pun, along with those other fossil fuels.
While the politics around energy may draw clicks, I guess people are just not that interested in energy itself. But the world which we enjoy today would not be possible without the extraordinary energy that derives from fossil fuels. It makes so much possible. I know many don’t like this sentiment: but I take the view that this energy source has brought more people out of poverty and done more to raise living standards than any other policy or substance in all human history. Almost on point of principle, therefore, we should be investing in it, especially in developing ways to produce and consume it more cleanly and efficiently, rather than abandoning it.
There is a profound hypocrisy to Net Zero, not only because it overlooks what fossil fuels have made possible, but because the ultimate source of most electricity remains burning fossil fuel. Just because that burning is out of sight, does not mean it is not happening.
Moreover, the metal required to reach Net Zero mean levels of mining unprecedented in all human history. How is that green or environmentally friendly?
Surely it’s more environmentally friendly to keep the old banger rather than buy some shiny new Muskmobile?
As if that is not enough, when the rest of the world is no taking no such steps, it is economic suicide to try and rid ourselves of fossil fuels. We are burdening our already heavily-burdened citizens with even higher costs, and it will make us even less competitive.
So it is with a certain amount of foreboding that we turn to the oil markets today. But turn to them we must.
Infuriating the Biden administration
Global oil consumption is around 100 million barrels per day (m b/d).
Though Venezuela has the world’s largest oil reserves, Saudi Arabia is the world’s largest producer, with an output of 11.5m b/d.
Venezuela is, of course, no ally of the US, but Saudi Arabia, broadly speaking, is. The US gives the Saudi government plenty of military and security “assistance” in exchange for its oil.
Perhaps I should have said was an ally, as the Saudis have made two announcements this past week, which will not please the Biden administration.
Last weekend, they, along with other major producers, announced a surprise production cut of up to 1,15m b/d. (The Saudis alone will cut by 500,000 b/d and Iraq by 211,000 b/d). This follows a previous reduction last October of 2 m b/d that, I think it’s fair to say, the Biden administration was not happy about.
Why do such reductions infuriate? They push up the oil price. That makes for even more discontented citizens in these inflationary times - citizens who will be less likely to vote Democrat next year.
The reductions also, effectively, increase the value of Russian oil exports. In these times of war and weaponised finance, the last thing the US will want to see is anything that increases Russian economic strength. Every dollar rise in the price of oil sees a $2.7bn increase in Russian annual export value is one stat currently doing the rounds. (Russia produces 7.5m b/d. 7.5m x 365 = $2.7bn).
Then there is the issue of the US’s strategic oil reserves. In an attempt to put a lid on gasoline prices, the Biden administration sold 180m barrels from the reserve last year for an average of $96.25 per barrel.
With falling oil prices this was looking like a good trade - as long as they bought back. Easier said than done. The plan was to buy back on the open market and replenish the reserves when prices reached $67-$72. That target was reached, but the administration, along with the entire investment world, we now know in retrospect, only had two or three days in March to buy the sub-$72 dip - and these were intraday moments. I doubt they managed it.
The US SPR now sits at 372m barrels - the lowest level since 1984. (The all-time high was 727m barrels in 2010).
Since the March 20 intraday low at $70, Brent has shot up to $85.
So now we turn to irritation number two: the strengthening of Saudi energy ties to China.
Another step along the yellow brick road to de-dollarisation
“The traditional monogamous relationship with the US is now over,” said Saudi analyst Ali Shihabi.
He said this last week in reaction to the announcement of a $3.6bn deal that would see the Saudis supply 480,000 b/d to China’s Rongsheng Petrochemical.
Saudi Arabia’s Crown, Prince Mohammed Bin Salman, rumour has it, says he is no longer interested in “pleasing” the U.S.
This follows a trade deal between China and Brazil (China is Brazil’s largest trading partner) to settle in yuan and reais, rather than dollars. It’s all part of this gradual de-dollarisation process that is happening. (China is already settling with Russia and Pakistan in yuan).
It’s not just de-dollarisation, it’s de-Westernisation. At 5.4% of its holdings, Brazil’s yuan-denominated foreign-exchange assets now exceed its euros.
At the “Russian Davos” - the St. Petersburg International Economic Forum - which was held last week in New Delhi, one Russian official, State Duma Deputy Chairman Alexander Babakov, stated that a BRICS (Brazil, Russia, India, China and South Africa) alliance was working on a new currency secured by gold and other commodities, including rare-earth elements.
“Its composition should be based new monetary ties established on a strategy that does not defend the U.S.’s dollar or euro, but rather forms a new currency capable of benefiting our shared objectives,” he said.
This is not a new concept - they have been speaking about it for some time - but de-dollarisation remains the broader direction of travel.
Oil stocks will benefit from a lack of investment
Coming back to the subject of oil, recession and sagging demand has seen the price slide since mid-2022. But we seem to have found a floor of around $70.
In 1980 OECD nations made up 70% of global demand. Now it is well below 50%. Demand forecast models, however, tend to focus on developed nations, though emerging markets consumption is probably more resilient. Global demand now exceeds 2019 pre-Covid levels. It is only going to increase. With all the money thrown at alternatives, annual demand keeps growing. The developing world wants what the developed world has. Who can blame them?
As well as geopolitical factors, investment in oil remains low, however. In 2014 it was $900bn, says the IEA. Today it is $400bn. Investment drives supply. Global stockpiles stand at 2003 levels. “If our models are correct,” says natural resource investment house Goehring & Rozencwajg, “inventories could end the year at the lowest reading since 1986.”
But “investors still refuse to allocate capital to the space”, they continue. “Over the last two years, energy has outperformed any other sector in the S&P 500 by 130 percentage points and the index by 150 percentage points. And yet, energy still represents less than 5% of the S&P500’s market capitalization – less than half its long-term average and 65% below the 2008 peak.”
Despite the outperformance, oil and gas are experiencing net outflows.
ESG plays a large role in this. Investment houses can’t invest even if they want to because of ESG guidelines. Anti-fossil fuel narratives that fail to take into account the amazing things that fossil fuels have made possible do not help either.
Western energy policy is steadily impoverishing Westerners. Instead of investing in and improving oil and gas production, we are replacing it with inferior, more environmentally harmful, more expensive sources. No wonder so many nations are economically de-Westernising.
“Despite weaker-than-expected second-half demand, we estimate that global oil markets were in structural deficit by as much as 500,000 b/d throughout 2022,” Goehring & Rozencwajg continue. It will be higher in 2023, they say.
This won’t change until there is a radical re-think of energy policy, which means a huge change in the discourse, in the narrative and in the personnel that determine it. We are years away from that. The lack of investment has been chronic for over a decade. It points to much further higher prices down the road.
The West will get left behind.
Can you say why I feel it is so important in a portfolio to have allocations to both gold and energy?
How to invest in oil
The easiest way to play this theme,