Oil and Stagflation Speculation

Written By: Tim Pierotti

Ask any experienced oil analyst what the next 10% move in oil is and you will likely get the same response: an eye-roll, a smirk, maybe a shrug. Seems like a fair question, right? The problem is that anyone who has worked in the energy patch for a couple years knows that he or she has no idea what the next move in oil is going to be. That is not to say one can’t have a long-term view of future oil prices based on global supply and demand factors, but to predict the next move in energy is a hubris that those in the profession are usually cleansed of early in their careers.

There are just too many factors to consider. Varying data quality, uncounted floating storage, supply shocks, speculative positioning, commercial hedges, weather, are just some of the unpredictable factors. Consider the current environment. Will the Houthi’s expand their attacks in the Red Sea? What is the real production capability at this point in Russia? How about Venezuelan and Iranian production over the next few months? What about enforcement or non-enforcement of sanctions? Will India increase or reduce inventories? All of these are basically unknowable.

With recent US economic data showing inflation bottoming and perhaps accelerating while growth appears to have softened a bit, we are all seeing headlines and speculation about stagflation. Stagflation is “Stagnant” growth amid accelerating inflation and a truly terrible environment for risk assets. Our view is simple: we aren’t going to see anything like stagflation unless oil prices move meaningfully higher and as we just laid-out, we have no idea what the next move will be in energy.

The US economy currently enjoys a long list of growth tailwinds. Accumulated wealth is still well above pre-pandemic and continues to grow with housing values and 401k’s. We have secularly tight labor markets pushing real wage growth and incomes higher. We also have ongoing fiscal overspend and savings are being drawn-down which increases spending and market optimism. For stagflation to emerge, there needs to be some pressure that offsets those tailwinds, like a spike in oil.

Oil is global and oil demand is no longer determined predominately by the US. Demand growth globally is overwhelmingly driven by emerging markets. These are countries where the average person consumes a tiny fraction of what the average person in the US and Europe uses. A recession in the US will make negligible difference to the demand of Indonesia, Malaysia, India, etc. Emerging Market demand growth is inexorable and while not entirely acyclical, it’s pretty close.

My point is that there is a long-term risk that when growth does slow in the US, oil may well remain strong and that is different than what we’ve seen in previous cycles when the developed world was the engine of demand growth. To be clear, the US is in an entirely different energy position than we were the last time we saw stagflation. The US is the largest oil producer in the world thanks to the Shale revolution, but that doesn’t change the fact that global consumption has evolved to a point where a potential US economic slowdown can be both precipitated and exacerbated by higher oil prices.

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