Remember the good old days when experts decided that the power of the OPEC oil cartel to control oil prices had come to an end? That fracking had made the United States the swing producer, ramping up production any time prices started to rise? That the future of the world’s economy would be based on forever-cheap oil and gasoline?
It was only two years ago that the price of the benchmark U.S. crude oil sold at an average price of a bit above $40 per barrel. Not as much fun for consumers as the $14 average price in 1998, but a lot better than the almost $100 price average crude fetched in 2008.
Until very recently the received wisdom was that any time the price exceeded something like $50 per barrel, U.S. producers would ramp up production from the ample supplies of shale oil they had tapped using fracking technology, and drive prices back down. Last week the oil market proved once again that it is no more predictable than the stock market: it hit more than $71 per barrel. And is headed higher. (The price of Brent crude, the European benchmark, is about $10 per barrel higher.)
It seems that the law of supply and demand has not been repealed. Demand is rising in response to the increased rate of economic growth, especially here in the United States, but also in most major economies. Meanwhile, supply is being constrained for a variety of reasons. Venezuela has been forced to cut back production as oil workers, unpaid, flee the country, and the government, its economy a shambles, is unable to invest in its oil fields. Analysts at Barclays estimate that the socialist country’s output this year will be some one million bpd less than last year’s 2.3 million bpd.
Iran’s output will also fall. President Trump’s decision to exercise the get-out clause in the Iran nuclear agreement, and reinstitute sanctions, is estimated to cut the Islamic Republic’s production of about 3.8 million bpd by anywhere from 380,000 bpd to 570,000 bpd. These and other unplanned cutbacks (Libya, Nigeria) come on top of lower production quotas maintained by OPEC and fellow-travelling Russia which aim to reduce a worldwide oil glut by removing about 1.8 million bpd from the market since early 2017. “I think we are where we are because OPEC got their groove back,” says RBC Capital Markets analyst Helma Croft.
And where we are is this: The International Energy Agency reports that inventories of crude oil are at their lowest level in three years. Excess supplies that weighed on the market since 2014 are gone. The price-restraining glut is no more.
So where are the frackers? Why don’t they open the valves and flood the market to prevent OPEC from achieving its new target benchmark of $80 per barrel? Because they are constrained by the shortage of labor and materials, and of pipeline capacity in West Texas that is needed to move oil from wellhead to market. And if Trump thought his new best friend, Saudi crown prince Mohammed bin Salman, would remove OPEC production caps to spare American consumers a jolt in gasoline prices just as the summer driving season starts, he underestimated the pressures on MBS (as he is referred to by friends and journalists seeking to save space). The crown prince is presiding over an economy that contracted last year and is projected to grow at a rate of only 1.7 percent this year.
- MBS needs a high crude oil price to maximize the value of the shares of government-owned Aramco, heading toward an initial public offering.
- There is an expensive war with the Houthis in Yemen to finance.
- The crown prince has undertaken a major reform of the Saudi economy, and needs all the cash he can get to keep various factions if not happy, then at least sullen, rather than mutinous, as he brings movies back to the Kingdom and prepares to allow women to drive. And to finance the lifestyle he manages to sustain in this time of austerity in Saudi Arabia—a $450.3 million Leonardo painting of Christ, purchased through intermediaries, a £452 million super-yacht, and a $300 million chateau on 57 acres outside of Paris.
And about all Trump has been able to do is tweet, “Looks like OPEC is at it again. Oil prices are artificially Very High! No good and will not be accepted.” The president could release reserves from the Strategic Petroleum Reserve, but that has never been an effective offset to a combination of rising demand and low inventories. Instead, Trump is reduced to hoping that higher prices do not slow economic growth or, worse, throw the economy into a recession (as they have done in the past).
The rise in crude oil prices has already translated into higher gasoline prices. At $2.90 per gallon, gasoline is up 28 percent from a year ago. That takes about $150 million per day out of the pockets of American consumers. Even more important to Trump is the fact that the typical Trump voter lives in rural swing states, typically drive less fuel-efficient older vehicles (and pick-up trucks), and already spend an above-average portion of their disposable income on gasoline. They will be hurt disproportionately. So will jet-fuel-guzzling airlines, truckers, and other sectors already buffeted by the cost pressures of a tight labor market.
But all is not as black as it was when OPEC flexed its muscles in past years. James Bullard, president of the Federal Reserve Bank of St. Louis, points out that an oil price shock that hurts consumers now also helps producers: “It more or less washes out at this point.” So as Trump’s working-class core supporters scrimp, his rich Texan oil producers party.
The president counts on the former for votes, the latter for campaign contributions. So perhaps the effect of higher gasoline prices on Trump’s electoral prospects more or less washes out, too.