With the US midterm elections only a couple of months away, we cut to a court room scene between a US voter, played by Tom Cruise, and President Trump, played by Jack Nicholson. You know the scene. And…action!
Voter: This war in Iran has caused higher energy prices. Your Treasury Secretary Scott Bessent has predicted oil prices could fall to $40-$50 per barrel after the Iran conflict ends, and you have claimed that diesel prices will drop below $2 a gallon, but we are currently paying $6. Are energy prices going to remain elevated??
Trump: You want answers?
Voter: I want the truth.
Trump: YOU CAN’T HANDLE THE TRUTH! Son, we live in a world that has debt and the interest on that debt is costing us more and more, and making us do crazy things like invade other countries and intervene in currency and bond markets. We need people to buy our Treasuries. Who is going to do that? You? Japan? China?
US consumers have historically paid very low prices for fuel. You have that luxury, or should I say, had that luxury, but with 2.5 billion barrels of oil ‘lost’ since February, and no agreement with Iran in sight, the oil price could go even higher.
You don’t want the truth, because deep down in places you don’t talk about at parties, you know that the situation is going to take months to resolve.
We use words on social media like ‘very strong’, ‘construction renaissance’ and ‘make America great again’. We use these words to confuse you. I have neither the time nor the inclination to explain myself to a man who refuses to believe my drivel on twitter, then questions why Scott Bessant can’t manipulate the actual diesel price lower! I would rather you just said thank you and voted for me again.
Voter: Mr President, energy prices are not coming down, are they?
Trump: I am doing a great job!
Voter: They’re not coming down, are they?
Trump: YOU’RE GODDAMN RIGHT THEY’RE NOT!
Crude Awakenings
I am not sure my remake of A Few Good Men will be as successful as the original, and I doubt any politician (especially Trump) would actually be that honest with the voters, but as we head towards the US elections, and bombarded with market signals we need to try to understand what they are telling us. Crude oil prices grab the headlines every day in the financial press, yet the more important signal is what is going on further on down the chain.
The current price of a barrel of oil is about $100, but given we are experiencing the largest oil and gas supply shock in modern history, you may have expected it to have been higher. The record oil price, set in July 2008, was $147 a barrel, but if you adjust for inflation this is about $215 in today’s prices.
Many of the factors that have stopped the oil price from reaching record levels are temporary. Inventory drawdowns, higher US exports, lower Chinese imports, and the use of sanctioned barrels cannot be repeated indefinitely.
The US has been draining oil from their Strategic Petroleum Reserve (SPR), but this reserve has now fallen to 294 million barrels, which is the lowest level since December 1982. The core mission of the reserve is to support the market quickly during a crisis, but operating below the 300 million barrel threshold pushes the aging infrastructure into uncharted and hazardous territory. There is an entire physics-based explanation of what happens if the level gets too low, which I am not even going to try and explain (unless someone explains to me first). But suffice to say, if the SPR loses its ability to pump oil at rapid speeds in a supply emergency then this leaves the US with dramatically less ability to cushion the blow of higher oil prices.
Crack to the future
Where the strain is really starting to show in the system is in the cost of refined diesel and gasoline. You can increase the availability of crude, but if the system cannot refine and move it into the products people actually consume, the economic pressure remains.
The diesel ‘crack spread’, the margin refiners make by turning crude oil into diesel fuel in the US, has soared to more than $100 a barrel, setting new all-time highs as a global fuel-making crunch continues to exacerbate fuel prices.
This is not normal, and signals refined-product bottleneck rather than a simple shortage of crude oil. Global refiners have been hit by drone attacks, Europe’s gas storage is low, and rising power demand from AI and electrification are all adding pressure. This spread is now at the highest level since October 2022.
The diesel market is flashing a clear warning, and the consequences are starting to be felt across the real economy.
While the daily newsfeed talks about oil prices, for 99% of people the cost at the pump is all that matters. Consumers typically don’t experience the full effect of an oil shock right away. The costs take months to travel from wellheads to refineries, fuel markets and eventually to consumers.
There is a school of thought in the market that if a US-Iran peace deal is announced (maybe just before the elections, eh ??😉) that oil prices will fall precipitously and inflation will get back under control.
There will be no doubt many traders who will sell ‘paper’ oil futures contracts on this news, as we saw in June, but the production and export of actual, physical diesel needed for farming, airlines, shipping, and most industrial activity remains severely constrained.
We are living in a world where both the Russian and Saudi energy industries are under attack, and getting refining facilities back online will take years. This combined with weather and climate pressures, which is already starting to show up in soft commodity prices, is a classic case of cost-push inflation i.e. higher input costs rather than excess demand, and leaves Central bankers in a difficult spot, as hiking interest rates won’t solve the supply issues.
Higher energy costs are here to stay, and we have positioned the portfolios to benefit from this through our holdings in commodity futures, global energy companies, and energy efficiency strategies.
Some people might believe the politicians when they are told that energy prices are coming down. There will even be some who believe that they will get a $5k cheque in the mail from Donald Trump for voting republican.
Not us. We can handle the truth.
Source: Fortune Magazine, FT, Bloomberg, Guinness Global Investors
