The “Real” Russia Collusion: Oil

© 2018 Steve Feinstein. All rights reserved.

Russian collusion is indeed a major issue threatening the well-being of our country. It’s just not the Russia collusion that’s been bandied about in the news for over a year. No, it’s Russia colluding with OPEC to intentionally raise world crude oil pricing. That is a real threat to our economy and living standard, unlike that other, totally imaginary Russia collusion.

In case you haven’t been paying attention, crude oil prices have been on an upward tear for the better part of the last two years. From a low in the high-20’s/barrel range in February of 2016, WTI (West Texas Intermediate) closed at $65.45 on Friday Feb 2nd. Goldman Sachs goes so far as to say that North Sea Brent crude oil (the other benchmark oil besides WTI) will likely top $80 within six months.

WTI generally runs about 5% lower, so look for WTI to be around $76/bbl by the summer of 2018.

Before we look at why this is happening, it’s a good idea for a quick refresher on the four main drivers of crude oil/retail gasoline pricing. Why is oil and gasoline rising? What’s happened?  First, let’s dispense with any simplistic “the oil companies are conspiring to raise prices” nonsense.  That’s not what’s happening. Oil is a commodity, traded on the world market like any other commodity, such as gold, copper, natural gas, diamonds, etc. Oil is subject to market forces like every other commodity is.

There are four main factors that influence the price of crude oil-retail gasoline on the world market:

  1. World supply/demand
  2. Exploration/extraction activity and technology
  3. Refining/delivery capacity
  4. Geopolitical influences (Iran, North Korea, terrorism, etc.)

(There’s also a 5th factor: currency value, or the “exchange rate,” since oil is traded in dollars. However, this is normally a peripheral factor that only shades oil pricing a little bit one way or the other.)

Today’s situation is primarily one of tightening supply coupled with greater demand as the worldwide economy, led by the U.S., continues to improve. See #1 above. When the world was awash with over-abundant oil in 2015-6, with loaded tankers sitting by the dozens offshore, unable to unload their cargo for lack of empty storage facilities, it seemed as if low-priced crude oil and $1.899/gallon gasoline was a permanent fixture on the US economic landscape. Never again would we be beholden to the arbitrary whims and evil manipulations of greedy, anti-American, anti-Semitic Arab oil sheiks.

The over-supply of oil was primarily because of the shale oil boom (fracking) in the U.S. With newly-developed exploration and extraction techniques, America was finally able to tap the previously unreachable mother lode of crude oil trapped in the huge shale rock deposits in the western and southern parts of the continental U.S. With a huge influx of additional oil being delivered to the world market, supply exceeded demand and world pricing plummeted.

At first, OPEC was unsure how to respond. Initially, Saudi Arabia actually increased their oil production in an effort to lower world pricing even more and drive the U.S. shale producers out of business (since shale oil has a far higher cost of production than Saudi oil, which is easy to extract).

That didn’t work. Shale extraction technology got better and better and the Saudis were never able to force pricing down far enough to permanently hurt the American frackers.

So, they resorted to the tried-and-true economic dictum of supply and demand. Led by the Saudis, OPEC instituted strict oil production quotas to limit the amount of oil that they would supply to the market. Restricting supply would re-balance the market and bring world oil demand and supply back into equilibrium, thus raising prices as market forces began to have their normal effect.

However, Saudi Arabia is only one of the top three oil producers in the world. Although the combined oil output of the 14 OPEC member countries is certainly significant (over 40%), the other two top three countries are the U.S. and Russia, each of whose oil output is roughly equal to that of Saudi Arabia (OPEC’s largest member). The Saudis convinced Russia to voluntarily join them in their production quota. With all of OPEC now joined by another top-three producer—Russia—the world’s oil supply has come down considerably, much faster than anticipated. Pricing is on pace to more than triple from its 2016 low and the impact on our economy and spending sentiment will be significant.

Note that the recent rise in pricing has essentially nothing to do with reason #4—terrorism and geo-political tension. As of right now, there are no hostilities with North Kores to rattle the world commodity markets, Israel is not at war with anyone and since the institution of the Iranian nuclear deal a few years ago, Iran is once again supplying oil to the world market without any problem. So the terrorism front is quiet right now.

The rise in price is all pretty much #1—supply and demand, with supply being restricted by the OPEC-Russia agreement. That fact points out the truth that even though total US oil production exceeds 10m bpd, the U.S. alone can’t determine the ultimate price of oil on the world market. We can be an influential factor—larger now, to be sure, than 20 years ago before the shale boom—but the U.S. can’t control oil pricing by itself.

Nor does the potential of future alternative fuels have much influence on today’s pricing. Some industry observers have opined that EVs (electric vehicles) will reduce worldwide oil demand by the equivalent of Saudi Arabia’s entire current oil production by 2040. But that, in reality, is just a random individual guess and such statements have no actual impact on today’s pricing.

Applying the rough approximate numerical multiplier of 4x to WTI crude to get U.S retail gasoline pricing, that means that U.S retail gasoline will be above the psychologically-important $3.00 mark (4 x 76 = $3.04) by this summer. People see the price of gasoline on the corner gas station every day as they leave the house. It’s like a daily “scoreboard” telling them whether they’re winning or losing their personal economic game. When Joe/Jane middle-class sees $2.27, they feel like they’re winning, like they can spend a little more somewhere else, like things are going in the right direction.

When they see gasoline rise very quickly, seemingly for no good reason, to $3.04—especially after a prolonged period well under $2.20—it’s a very negative sign. Maybe things are getting worse and I haven’t been paying attention. Maybe I should play things safe for a while, keep things close to the vest. Let’s cut down on dinners out and tell Johnny, sorry, no new sneakers just yet. Yeah, I know my brother Bill finally got a job again after two years, but let’s not get too carried away.

Rising oil pricing impacts everything at retail, in the construction and agriculture sectors and in manufacturing, because everything is delivered from the factory to the seller and from the seller to the end user by a transportation device that uses an oil-derived fuel. Milk, sushi, iPhones, lumber and fertilizer are all made and delivered with the assistance of oil-based products. Rising oil pricing also negatively impacts business and domestic heating and utility pricing. It’s like a tax that takes billions and billions of dollars out of the economy, wrecks the exuberant business outlook and shreds consumer confidence. Rapidly-rising oil pricing is a five-run uprising in the 9th inning of a game you were leading 8-1 after eight innings. Now you’ll just be happy to hang on for the win.

Consumer and business sentiment is central to the spending that drives our economy, the very backbone that supports it. Anything that puts a damper on that sentiment will drag down spending and hence drag down economic growth along with it.

Russian “collusion” is indeed a big threat to our country’s well-being: It’s the collusion between OPEC and Russia to restrict the world’s oil supply and drive up pricing. It’s working and the tangible, undeniable, clear-as-day proof is posted in big numbers on every street corner. Maybe the media should pay some attention to that.

 

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