Oil Just Fell To A New Low. What’s That Mean For Inflation?
At their heart, financial markets are very straightforward. They are simply attempting to measure future supply and demand. Whether for a company’s product or service or a commodity, all of the effort expended on Wall Street and all the financial capitals worldwide are focused on this one point: future supply and demand.
Understanding, then, that the supply-demand equation is always our starting point, the recent behavior of Oil is particularly puzzling. The price of West Texas Intermediate, the US Bench Market oil, just fell to a new yearly low early this week.
Price reduction, how can that be? Everything we read about Oil tells us that the Oil supply is rapidly declining, at least for the Western Nations. First came the boycott of Russian Oil by NATO and the United States. Then the sabotage of the Nordstream Pipelines again supplies destruction. Reports of several oil tankers stuck in the Bosporus surfaced yesterday, along with a leak in the Keystone XL Pipeline, which has been shut down. Across the board, one supply shock after another.
And yet, Oil is not rising in price as we would expect. Oil is falling in price, as it has been since summer. The price behavior of Oil is fascinating. After hitting a high in March, at just over $130 per barrel, Oil hit a second high in June in the mid $120s per barrel. Oil is trading at roughly $72 per barrel, a 45% reduction in price.
Terrorists destroyed the Nordstream Pipeline, yet Oil continued to decline in price. Not even yesterday’s announcement that the Keystone Pipeline, a source of 600K barrels of Oil per day, not even that news was enough to rally the price of Oil. And all this price decline has occurred just as those supply shocks hit: Russian boycott, no matter whether Oil went lower.
Oil, a subset of petroleum, is our most important energy source. Most homes in the nation use natural gas for heat, and transportation trains, planes, and buses use diesel or jet fuel, both oil derivatives. Increasingly electric power plants use Oil or natural gas to generate electricity.
Oil prices are also critically important in this country’s battle against inflation. The inflationary spiral we are in currently began with the increase in the price of Oil earlier this year. Oil and its chief derivative, gasoline, have been the number one driver in the Consumer Price Index for the past months. The Index measures inflation for the everyday citizen.
Only after Oil ignited the inflationary fires has the rest of the economy joined in. The rise in oil prices increases the cost of living. Higher costs become a vicious cycle where businesses raise prices to meet growing energy costs. The workers demand higher wages to meet the increasing cost of living. And around and around, we go in a steadily escalating price spiral — a spiral begun by Oil.
The Federal Reserve has gotten in by trying to stamp our inflation, primarily by raising interest rates.
All of a sudden, Oil, the commodity that started this inflationary fire, has cooled off. Oil prices, as we said, are down dramatically. At least here in the United States, Oil prices are not a current concern. The entire complex is down in price. And just as winter begins, those predicted astronomical prices are suddenly gone.
Now, things are different for Europe and Britain. I’m just speaking for the US.
Unfortunately, there is one last thing to consider. Please remember that we started this discussion by watching the importance of the supply-demand dynamic. There are only two circumstances where prices decline, increasing supply or decreasing demand.
There is little to indicate that the nation’s oil supply is increasing. On the contrary, we have been reducing supply by eliminating Russian imports (about 10% of our total supply), prohibiting new exploration, and additional pipelines. Since the economic shutdown during the Covid Pandemic, the number of active oil wells is about half the level before. Discoveries have been practically nil, and few prospects are being brought online.
So, overall supply looks to decline significantly in the future. And remember, financial markets are always looking into the future.
So if markets are not looking for increasing oil supply in the future, we’re left to conclude that the driving force behind lower oil prices is reduced demand- a recession or worse.
Yet another indication that Global Inflation is slowing. China announced last night that its annual inflation rate is now down to 1.6%. That’s about half of China’s target inflation rate of 3%, and back to the level of inflation before all this began. Before the COVID Pandemic and before the economic lockdowns.
China did release some of its pork reserves from the national storage facilities, which helped reduce food inflation. Nonetheless, to miss target inflation by this much indicates far less price pressure in the Chinese financial system than authorities thought.
In just a few minutes, the United States will release its latest report on Producer Prices. If analysts are correct, the PPI should show a gain of 2/10ths%. That’s an annual increase of less than 3%, far below the actual rate of 8%. We’re also seeing a dramatic reduction in inflation at the wholesale level for America.
Then, the University of Michigan will report on its latest consumer survey in a couple of hours. Overall sentiment by the average US consumer is expected to show little change.
There are no significant earnings reports today.
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