Passing the buck on higher energy prices

Bottom Line

With the first debate between President Biden and former President Trump only a week away, interest in the November 5 election is heating up, and polls suggest that inflation remains voters’ biggest economic concern. Over the past three years, prices for food, shelter, insurance, electricity and energy have soared along with wages, sparking the worst U.S. inflation in four decades at its peak two years ago. To be sure, the pace of inflation has slowed materially since then. But prices across the board generally remain elevated by some 20-25% compared with pre-pandemic levels. 

Politics at the pump Gasoline prices are a highly visible touchstone, with an historically tight inverse relationship to presidential approval ratings. President Biden’s weighted-average approval rating at present is about 37%—not particularly good. But according to Strategas, if gas prices at the pump rise about 15% from their $3.46 national average now to perhaps $4 per gallon during the summer driving season into Labor Day, history suggests his rating might shrink to 35% just as early voting begins. We’re expecting an active summer driving season sparking strong demand for gas. Depending upon supply constraints, then, it’s certainly possible the per-gallon cost will rise, as gasoline prices hit $5 per gallon as recently as June 2022. 

• Energy prices higher Crude oil (West Texas Intermediate, or WTI) rose 30% from $68 per 42-gallon barrel last December to $88 in early April 2024, before declining 17% over the past two months to an oversold $73. We were forecasting a rally in crude to $80-90 this year, with a potential spike to the high of $95 per barrel reached in September 2024. WTI has rebounded about 10% to $78 per barrel over the past fortnight. Lagging retail gas prices rose by 20% from $3.06 per gallon last December to $3.68 in mid-April, before declining by 6% to $3.46 per gallon now. We believe gas prices could approach or exceed $4 per gallon later this year, for several reasons: 
• Cartel keeps production cuts in place The Organization of the Petroleum Exporting Countries and its allies (collectively known as OPEC Plus) met earlier this month and decided to keep their collective productive cuts of 4.66 million barrels per day in place through next year to keep crude oil prices elevated. As the two major producers within OPEC Plus, Saudi Arabia and Russia each produce about 9-11 million barrels per day. The Saudis have said that they need an $80-90 price to fund their internal government budgets, and they recently sold some shares to the public from their stake in Saudi Aramco to raise as much as $13 billion. Russia has been using the proceeds from their energy production to fund their ongoing war with Ukraine.
• Russia/Ukraine war Since its start in February 2022, the Group of Seven (G-7) countries installed artificial price caps of $60 per barrel on Russian crude oil to limit their sales volume and Russia’s ability to generate revenues to fund its war effort. But the policy has been a colossal bust, as Russia has sold as much oil as it wanted to China and India instead. It, too, is motivated to keep prices high.
• Geopolitical risk Aside from the Russia/Ukraine war, now in its third year, Israel’s war of retribution against Hamas is now in its eighth month, with no end in sight. Moreover, there is a growing “Axis of Evil” alliance between Russia, China, Iran, North Korea, Hamas, Hezbollah and the Houthis, who continue to attack oil tankers in the Red Sea. We can’t completely discount the possibility of a Middle Eastern oil embargo to punish the U.S. for its support of Israel. 
• Environmental impact The International Energy Agency reported this week that oil-demand growth could peak at the end of this decade and then contract, as the rollout of clean-energy technologies accelerates. This could reduce fossil fuel prices longer term. It identified rising electric vehicle (EV) sales, fuel-efficiency improvements for gas-powered vehicles and the use of renewables for electricity generation, such as wind, hydro and solar. But the agency also acknowledged the risk that the pace of adoption of EV’s and renewable energy may not meet its lofty goals. In fact, there’s been a wave of merger-and-acquisition activity among oil and natural gas companies over the past year. That suggests that they expect energy demand and prices to remain firm for the foreseeable future. 
• Currency volatility The relative strength or weakness of the U.S. dollar compared with the euro, pound and yen also has a bearing on energy prices. This also depends on the relative strength of their economies and whether their central banks are tightening or loosening monetary policy. With the Federal Reserve on hold and the U.S. economy somewhat stronger, the dollar is again strengthening against the currencies of our three major trading partners, lifting crude oil prices. 
• Weather or not? The National Oceanic and Atmospheric Administration is expecting a brutally hot summer with the potential for a record-breaking number of hurricanes this year. If true, and if any of those storms are unleashed in the Gulf of Mexico, then damaged refineries or drilling rigs could spike crude oil prices, at least temporarily.
• Strategic Petroleum Reserve is a political football With gas prices hitting $5 per gallon in mid-2022, Biden released roughly half of the U.S. oil reserve to reduce pump prices ahead of the midterm elections. In the past, the U.S. tapped it if a weather disaster damaged our refining or exploration & production capacity. But the administration has not refilled the four underground salt caverns in Texas and Louisiana (holding about 727 million barrels of crude oil when full) constructed in 1975 after the Arab oil embargo to provide an emergency stockpile. It is down to about 369 million barrels (50% capacity), and the U.S. could be susceptible to a weather catastrophe or disruptive geopolitical developments.

Passing the buck A study by the San Franciso Federal Reserve published in May concluded that the elevated inflation in the U.S. over the past three years was not caused by corporate price gouging. Instead, its roots can be traced to companies raising prices to protect profit margins, due to spikes in energy, labor, rent, insurance and commodity prices. Government officials, however, routinely blame price gouging, corporate greed, “shrinkflation,” “greedflation” and former President Trump’s fiscal policies for these sharply elevated costs. So, if we genuinely want to reduce energy costs, they should approve canceled pipeline projects, expand fracking and offshore drilling, increase exploration and production activity in Alaska and streamline the permitting and regulatory process. The U.S. is the largest energy producer in the world, producing more than 13 million barrels per day. Econ 101 informs us that the best way to bring energy prices down is to create more supply relative to demand.

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