By Daniel Lacalle, Mises Institute | September 21, 2023
Oil prices are soaring, and, as always, we read in many articles that OPEC and Russia are to blame. However, if OPEC and its allies were almighty and the drivers of oil prices, why have Brent and West Texas Intermediate (WTI) crude plummeted in 2022? OPEC only reacts to demand, but it is not a price-setter. It is a price-taker.
WTI is up 13% year-to-date, but it only started bouncing in May. WTI is only up 6% in the past year. At $90.7/barrel, it is still far away from the June 2022 high of $122/barrel and barely reaching the levels of November 2022.
What made oil prices plummet from their June ’22 highs? Rate hikes and monetary contraction sent the entire commodity complex down to pre-Ukraine invasion levels despite production cuts, geopolitical risk, and the Chinese re-opening. Commodity prices are driven by monetary factors, and the hawkish stance of global central banks accelerated the decline despite supply chain challenges and limits to production. Added to the decline in the money supply and rate hikes, the United States and non-OPEC production offset the negative impact of Russia and OPEC limits on some exports. Competition works. Finally, oil prices stumbled as Asian demand ended up being weaker than estimated, with global industrial production declining, particularly in developed economies.
The weakness in crude was a combination of monetary factors, increased United States supply, and weaker global demand. Those three factors have now reversed at the same time.
We cannot blame OPEC when prices rise and ignore them when prices fall.
The biggest challenge for the oil market in developed economies in the next five years is self-inflicted.
Governments and financial institutions all over the world declared war on investment in fossil fuels under the misguided view that supply and prices would not be affected. According to JP Morgan, there is a chronic underinvestment in the oil and gas complex that exceeds $600 billion per year. In 2022, with oil prices rising to the previously mentioned $122/barrel, companies all over the world continued to reduce investment in exploration and production. Development capital expenditure was kept to a bare minimum, and even some European oil and gas giants started selling their “net zero emissions” strategy, ignoring the global energy reality. Total oil and gas investment came below depreciation for the sixth year in a row, according to Goldman Sachs.
The energy transition cannot happen through ideological imposition. It requires technology and competition. Destroying the incentives to invest in oil and gas and imposing an ideological, not industrial, view of energy has made developed economies more dependent on fossil fuels.
When politicians decide, they willingly ignore economic calculations because they believe that the political world dictates prices, not supply and demand. Economic analysis has been abandoned, and the result is an exceedingly negative scenario.
Developed economies have destroyed all incentives to invest in diversification and security of supply of oil and gas driven by an ideological view of the world without having a feasible, abundant, and flexible alternative. Thus, when the United States administration imposes more restrictions on oil and gas investment and the European Union decides to reduce nuclear capacity and ban the development of domestic resources, all they have done is make their economies more dependent on foreign suppliers.
Western governments now demand that OPEC produce more while, at the same time, saying that their nations will not use fossil fuels in ten years. This is the imaginary deal that we, in the West, offer to oil and gas producing nations: “Dear oil and gas producers, you have to produce as much as we demand and sell it cheap, investing billions of dollars in development, but we will not use your product in ten years”. I imagine there is no rush to sign such a deal.
It is hard to believe that the global emerging market producers will be thrilled about the prospect of eliminating their energy exports only to import more “energy transition” engineering from developed nations.
According to OPEC sources, there could be a two-million barrel-per-day supply shock in the winter of 2023. Other analysts are more prudent but still see a market that is tight today and may be getting worse as the underinvestment toll becomes more apparent.
The entire bounce in oil prices since May is driven by the rushed decision of central banks to stop the monetary tightening before the inflation battle has ended and by the misguided decision to limit investments in domestic resources in the middle of a geopolitical battle without a clear alternative. Governments have created their own supply shock by placing ideological views in the energy industry. The alternatives are not evident yet; technology and availability have not been fully developed, but politicians have already decided when the transition must be completed.
Crude oil did not replace whale oil due to the decisions of environmentalists or politicians. Crude oil displaced other sources of energy because it was easier to store, produce, and transport. Crude oil and natural gas proved to be abundant, easy to manage, and economically efficient. This is the first time in human history that the energy transition has been decided by politicians without allowing technology, competition, or human ingenuity to come up with a better, more flexible, and more economical alternative. Renewables are great, but they are intermittent and volatile. We need to allow the world to produce alternatives when they can truly replace the current energy resources without destroying our lifestyle and economy.
We may blame OPEC for rising oil prices, but the fact is that they only react to weak demand and low prices. OPEC may increase production at its next meeting, but the reality is that the energy supply issues have been created by Western governments and may persist. Instead of allowing all sources of energy to compete and allocation of capital to generate the investments needed for security of supply and energy transition, what has happened is that we may have created an energy crisis by political design. The alternatives are not ready, and the domestic resources that could limit prices have been banned or severely limited.
The irony is that anyone who understands energy knows that there is no successful energy transition without natural gas and nuclear, and this requires incentives to invest in energy security. Governments will not back down, and they will prefer a decline in energy prices coming from a deep recession to an improvement coming from diversification and investment.
This may be yet another energy crisis created by political design. Unfortunately, instead of learning and changing, many developed nations’ policymakers will prefer to impose restrictions on consumers. Ultimately, the incorrect planning of this energy transition is not a question of energy sovereignty or climate change, but a way to control citizens. That is why many governments prefer to see soaring energy prices, because that will allow them to impose restrictions on consumers.
Daniel Lacalle, PhD, economist and fund manager, is the author of the bestselling books Freedom or Equality (2020), Escape from the Central Bank Trap (2017), The Energy World Is Flat (2015), and Life in the Financial Markets (2014). He is a professor of global economy at IE Business School in Madrid.
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