Earlier this week, the markets got some seriously bad news…
Consumer prices spiked 6.2% year-over-year to their highest level in more than 30 years.
On top of that, producer prices — the prices that drive consumer prices — reinforced the bad news. October continued to show a whopping 8.6% increase from the previous year.
The Fed is still trying to portray these pressures as transitory. But for his part, President Biden — in typical political fashion (a written statement) — had to address the elephant in the room…
“And on inflation, today’s report shows an increase over last month. Inflation hurts Americans’ pocketbooks, and reversing this trend is a top priority for me. The largest share of the increase in prices in this report is due to rising energy costs—and in the few days since the data for this report were collected, the price of natural gas has fallen.”
And then – in typical fashion of someone who doesn’t understand how economies work — he added…
“I have directed my National Economic Council to pursue means to try to further reduce these costs, and have asked the Federal Trade Commission to strike back at any market manipulation or price gouging in this sector.”
Well he got one thing right at least — prices are soaring.
Energy prices specifically have been on a tear for the better part of this year.
So let’s take a look at what’s going on in the energy sector and see what the president might be able to do about it…
Joe’s Not Wrong
I spent 20 years trading in the energy markets. And natural gas traders were a special kind of crazy…
The natural gas market is known in the business as the “widow maker.” The contract sizes are huge (every 0.01 price tick up or down is worth $100), the price swings are extremely volatile, and daily price limits can end your career if you get caught on the wrong side of the market.
Recently gas prices are up over 200% since September of 2020. Have a look…
You can see that prices have come off over the past few weeks. But you can also see that this last leg up has taken out previous highs in a range that has contained prices for the past decade or so.
We need to look at crude oil prices a little differently.
You can see in the chart below that crude exhibited the same panic collapse we saw in so many other markets. Because of that we really can’t say “the market is up 600% from its 2020 lows…”
WTI Crude Oil
If we take 2020 out of the equation and normalize the picture a bit, crude had been trading in a range between $76 and $43 during the two previous years — an average of which comes to around $59.50 (the solid line).
At around $81 per barrel, crude prices are up 37%. You can see that it’s taken out some recent highs as well (the dashed line).
Energy prices are definitely challenging their upside limits. So what’s driving these moves?
Public Enemy #1 — Inflation
The only thing “transitory” about the current state of inflation are the conversations about it being transitory.
We’re basically replaying the conditions that produced the “Great Inflation” of the 1970s. (Which actually started in the mid-1960s and didn’t end until the mid-1980s.)
First, there was bad fiscal policy on the part of the government. President Johnson’s massive deficit spending on his Great Society and the Vietnam war (spending which lasted into the 1970s) put the country in a massive hole.
Then there was bad monetary policy. Going into the 1972 presidential election, President Nixon ordered his hand-picked Federal Reserve Chairman, Arthur Burns, to force interest rates lower to spark short-term economic growth. It’s claimed Nixon said, “We’ll take inflation if necessary, but we can’t take unemployment.”
There were artificial market manipulations that tried to control the overall economic situation. Nixon imposed wage and price controls that exacerbated price increases when they were finally lifted.
Finally there were two huge disruptions in the supply chain of oil (the Saudi embargo of 1973 and the overthrow of the Shah of Iran in 1979) that led to gas rationing and soaring energy prices.
It would be nice to think we learned a thing or two from that time. But we haven’t. Today things look more like the 70s than ever…
Sensible monetary policy has been abandoned to effectively keep the defibrillator paddles zapping the markets.
The Fed Funds rate has been pushed to ZERO and held there for the past 12 years. (When Jay Powell tried to tap the brakes and normalize rates in 2017 and 2018, Donald Trump pushed him to put the Fed’s foot back on the gas.)
Fiscal policy has gone insane. I’m not kidding!
In 2008, Hank Paulson asked the U.S. Congress for an UNTHINKABLE $750 BILLION to save a crashing global financial system.
Today, since the 2008 crisis, the Fed now holds over $8 TRILLION in monetized debt on its balance sheet.
Over the last 18 months, Congress appropriated a total of $4.7 TRILLION in COVID-19 relief spending.
And Joe Manchin says he’s open to discussing $1.5 trillion in “human infrastructure” spending (as opposed to the administration’s original $3.5 trillion version).
In what universe is saying “I’ll go $1.5 trillion” fiscal sanity???
Supply chains are in disarray (and that’s putting it mildly.) Shortages are squeezing prices everywhere.
And the labor market is struggling to return to pre-pandemic levels. This has led employers to offer higher wages and other incentives to attract workers — which will ultimately show up in prices.
I still don’t know what the Fed thinks “transitory” means, but this situation won’t resolve itself for at least another year.
The other driver is simpler…
Biden Hates Pipelines…
…And apparently pretty much everything else related to hydrocarbon-based energy.
Whether they actually are his programs — or he’s working at the behest of the progressive left who harbor a “green new dream” of a world where the sun powers everything for free — his actions have been a direct assault on the energy sector.
On day one he canceled the Keystone XL pipeline. Pipelines are the safest, most efficient, most economical way of transporting oil and gas. The supply of oil it brought in from Canada hasn’t stopped as a result of his action. It’s just made moving it slower and more expensive for producers.
He ordered a 60-day pause in the issuing of drilling leases on federal lands, cutting oil companies’ ability to produce. (He’s also promised to make these permanent.)
He reinstated methane regulations calling for “substantial reductions in U.S. methane emissions.” It’s estimated these regulations will cost the industry $600 million to comply with. And in case you weren’t aware, methane emissions don’t just come from the agriculture industry (cow farts). Oil and gas infrastructure, landfills and other industries will also be impacted.
By the way… If you think a $600 million price tag is a pittance for an industry that generates tens of billions in revenue is a big deal, realize that nationwide there are over 750,000 wells that generate less than 15 barrels of oil a day. These small producers are known as “stripper wells.” These regulations are existential threats to these producers who simply don’t have the scale and resources to keep up.
He’s recently initiated a study on the impacts of closing another pipeline — the Line 5 pipeline — that supplies about 540,000 barrels of oil and gas to the midwest every day.
Finally he’s looking to eliminate tax deductions and regulatory advantages to hydro-carbon based producers including intangible drilling cost deductions and “depletion tax breaks.”
None of this is friendly to the oil and gas industry.
So what’s been the (predictable) result?
Well anytime you add regulations that increase the cost of production, producers will make less. All this initially resulted in a 26% decline in U.S. oil production.
U.S. Crude Oil Production
So prices are up and production is down. Let’s get back to our original question — what can Joe do about getting inflation under control?
Dealing With the Real Market Manipulators
The first thing the president needs to understand is that oil and gas add to the price of EVERYTHING — not just what you pay directly at the pump. Planes, trains and trucks all have to put fuel in their tanks to move products to their destinations.
And more expense to them ends up as higher costs for the consumer. But wait… there’s more!
Transportation isn’t the only area affected by energy prices.
Oil and gas are used it the production of thousands of high-tech and everyday products… from tires to toothbrushes to laptops to phones to hearing aids to heart valves and tons of other essential goods. They’re even used in making the blades for wind turbines — yes wind turbine blades!
A sustained increase in the prices of gas and oil will ripple through all kinds of markets.
Let me say it again… Oil and gas prices impact the price of EVERYTHING…
And Biden’s policies have created massive disincentives to drill and produce more oil. (The jury’s still out, as far as I can see, on whether these changes will become permanent.) That means these actions alone will keep prices elevated for the foreseeable future.
And here’s another angle to consider…
You can’t simply turn something as vast and intricate and complex as the global supply chain off. Then expect to flip a switch and have it all come back up like the cable box in your living room. It’s gonna be a looooong time before the whole thing is back up and running smoothly.
In the meantime these policies are exacerbating the pain being inflicted by the supply chain.
The role of any government in business should be to provide a business-friendly environment.
If the president wants to address inflation, he MUST address energy prices.
If the president wants to rein in energy prices by dealing with market manipulations, he’d better take a look at his own policies first!
Otherwise “transitory” might mean until 2035…
Make the trend your friend,
Editor, Streetlight Confidential