High gas prices have become yet another highly politicized – and almost universally misunderstood – feature of our lives.
Theories for the rise in prices at the pump over recent months include everything from the scrapping of a pipeline (which didn’t even exist yet), through to some kind of Democrat conspiracy. The truth, I can assure you, is much less fanciful - and sits firmly within the basics of economic principles.
As with most changes in price of practically anything, it boils down to the delicate interplay between the forces of supply and demand. For extra dramatic effect though, Wall Street and an international cartel were also involved.
Read on to get my full take.
When COVID-19 took the world by storm in early 2020, life very quickly ground to halt. Literally, people stopped going anywhere by road, by air, or by sea. Demand for goods and commodities shipped internationally also went off a cliff. This sudden halt to the movement of people and goods resulted in a near-instantaneous collapse in demand for oil. The price of West Texas Intermediate (WTI) crude, incredibly, hit a record low of negative $37.63 per barrel.
In response, the world’s major oil producers quickly scaled back production in an effort to arrest the drop in price. This worked very well. So well in fact that they have not yet restored production to pre-pandemic levels.
As the world emerged from the worst of the lockdowns and border closures, oil demand, unsurprisingly, began to surge. Production has gradually increased from it’s mid-2020 low through to now, but remains a way shy of the pre-pandemic level…which is one of the main reasons why you’re now getting stung every time you fill up.
The return to pre-pandemic production levels would require the cooperation of the world’s largest oil producing nations, which include Russia, Saudi Arabia, Iraq, Iran, China, Canada and UAE among others. Looking at some of the names in that list, you can probably see why full cooperation may not immediately be forthcoming…
It takes significant, ongoing investment to maintain, let alone increase, oil global production. There needs to be exploration, rigs need to be built and deployed etc.. It’s an expensive proposition. Unfortunately for oil producers, they’re now living in the era of ethical investment. This means the amount of investment available for fossil fuel projects has been dwindling since the mid-2010s. Investment in new wells in the US alone has fallen by more than 60% since before the pandemic.
Before we give Wall Street too much credit for being ethical though, domestic wells became a terrible investment some time ago. 2014 was a particularly bad year for US fracking operations amid tumbling oil prices. Over 40,000 oil and gas wells were drilled in the US between 2011 and 2014 alone, but the industry never fully recovered.
Given that investment in the sector has been lagging for some time now, it’s possible that we may be facing structurally higher oil prices for a while to come – and we expect higher energy prices will remain one of the less transitory aspects of currently hot inflation.
Well…tough to say. It seems that OPEC (Organization of Petroleum Exporting Countries), the international cartel I mentioned in the intro, will probably continue to increase production at a snail’s pace. The rate at which they might increase remains to be seen though. Prices at the pump across the US have already fallen a little compared with a month ago, but are still significantly higher than a year ago.
One storm cloud on the horizon is Russia’s seemingly imminent move on Ukraine. Needless to say, this would have terrible consequences on a human level – and could result in expansive sanctions being placed on Russian crude. This would not mean good things for consumers of petroleum products.
There is something of a longer-term silver lining here though. An extended period of higher prices at the gas pump are likely to cause people to substitute away from internal combustion engines - and toward cleaner/cheaper to run EVs - at a faster pace. After all, moving away from fossil fuels is not only much better for our health and that of our planet, but it also snicks the cash flow of some of the world's most unpleasant dictators and regimes. Personally, I'm a fan.
If ethical investing is something you're into, why not move your money over to us? It's what we do.
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