Introduction
After printing trillions of dollars and triggering a level of inflation in the developed world that had not been seen in almost 30 years, the FED has been rising interest rates to try to reduce inflation. However, it seems that it is not only missing its target but also cracking the financial markets.
The cost of living is rising considerably, and the main reason for it is energy prices. The pressure on producers during the last years, the incentives to disinvest in fossil fuels and explore other alternatives and the high burden of taxes on benefits (after forgiving the sector in the worst moment of Covid) entailed that companies are using their benefits to
As the FED cannot produce energy to relieve the inflation problem, it needs to use its tools to
reduce energy consumption. Namely, the FED needs to create a global recession.
The FED is trying to do that by rising interest rates. This is critical for overleveraged institutions that cannot face interest expenses, normal businesses as they find it more expensive to access credit, and other countries which see their currencies fall against the dollar. The main result of this movement is to slow growth and increase unemployment. Moreover, it is like a torpedo to the line of flotation of developing countries whose currencies are the weakest and they pay their energy imports in dollars.
The new geopolitical chessboard
We should look at the geopolitical chessboard having clear that each government will take any decision that makes its citizens wealthy even if that entails causing damage to other countries. The US is trying to produce a crisis in
On the other side, there are countries in which money from oil exports means a large part of the annual budget. As it happens with OPEC members, which act like carter and have a lot of power because oil is the engine of modern economies, and its demand is very inelastic. Take as an example the fact that the oil demand barely fell 15% (15MM barrels) in 2Q20 with the Covid-19 outbreak. The Great Financial Crisis (2008) diminished the oil demand by only around 5%.
Currently, the supply/demand for oil is practically balanced. However, there is a material lack of supply which has been balanced thanks to the fact that the Biden administration decided to release 180 Million barrels for electoral purposes (1MM bbl/d from April to October 2022), instead of incentivising production. This movement damaged Brent prices infuriating OPEC allies.
Nevertheless, the situation is changing. The SPR (Strategic Petroleum Reserve) is ending in less than a month (-1MM bbls/d supply). Moreover, China is expected to full reopen before the end of the year (+2MM bbls/d demand). Russian oil production is expected to start declining (-0.5-1MM? bbls/d supply), plus the (-1MM bbls/d real supply) cut in OPEC+ production leaves a deficit of 4.5-5MM bbls/d.
OPEC is well aware that the FED can reduce the demand for 2023 by 3-5% by continuing rising interest rates at this pace and creating a global crisis. It would hurt especially developing countries which have vast amount of populations and consume large quantities of oil.
However, OPEC is determined to maintain the Brent price in the $100-$110 range. It was shown last Wednesday cutting 2MM bbls/d from its production quota. Another proof of its determination is that this week, Saudi (OPEC leader) has diminished the oil price for Europe but it has maintained the price for Asia. It is a clear message for China as it is releasing oil from its SPR.
At this point, its main goal is to corner the FED to be less aggressive with interest hikes. They want to show the FED that they cannot tackle inflation as they cannot have under control its energy component.
With this week’s movement, Opec is showing that it has more
This happens just before the mid-term elections, as a reminder that if they continue their hawkish plan and break a considerable part of financial markets, they will enter a recession and it is quite probable that they cannot have cheap oil, which would be especially damaging for the Biden-Administration.
We got used to the fact that the US usually wins its geopolitical clashes. Nevertheless, it appears that it has committed a critical mistake in its energy transition plan, disincentivising oil production before having a real plan to substitute it. After all, the FED can print trillions of
Summary
This year, we witnessed an earthquake in geopolitics in the aftermath of the invasion of Ukraine. Energy is the new battlefield and we are watching how the main superpowers of the last century are losing ground. Since the last year, even before the war, we have been talking a lot about the consequences of the natural gas problem in Europe and how we think that it is going to last several years. Nevertheless, the US is also in a non-ideal position. Its privileged position is in part because the dollar is the currency of the oil business. Russia, China and Saudi have been years trying to commercialise in different currencies other than dollars. The use of other currencies is increasing considerably in the last few months. We believe that it is imperative for the US to have Saudi on its side as it is critical to its interest.
It does not feel like this relationship is going to improve in the short term. And if the OPEC weaponise energy as it looks like
We believe that this situation only reinforces our idea that the energy sector is going to overperform the rest during the coming months. As we explained in the 3Q22 letter, we feel very comfortable having energy as the central sector of the portfolio.
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