You know what they say about when you have “friends” like these. Trading across the oil market this week is one for the books, if the familiar set of them. The WTI curve blew way out in a matter of days as desperate oil traders sought to pay – through the nose – for anyone with some spare crude before they might have to deliver next month.
They call it backwardation but it’s really just a premium on physical availability. Because the spot or short-term contracts are priced in this case way above those just a few months into the future, if you are lucky enough to have or be able to acquire a shipload of crude you can make a fortune selling it now rather than waiting.
That’s because trading in the WTI futures market very nearly came unglued. The calendar spread between the front month contract and the very next one in line, the smallest single-month spread, shot from $0.62 on September 20 to $2.36 a week later. The 3-month calendar spread blew way out, rising from an already-rich $2.26 on the 14th to $4.70 by the 22nd and then $6.32 on Wednesday.
These are the kinds of curve shapes last seen during last year’s near-crippling energy shock.
It’s a great position to be in if you are heavy crude. And it is a situation that was specifically engineered by our “allies” in Riyadh. You might remember a few months back how Saudi Arabia’s oil minister Abdulaziz bin Salman Al Saud unveiled what he colorfully called the country’s “lollipop”, a commitment to cutting back on oil production in the kingdom in order to “sweeten” the price.
This is also a reminder of how things have changed, and how much the Saudis had to come up with to make it change. To begin this year, the United States was suddenly awash in spare crude, a veritable glut that nearly filled storage capacity in the space of only six or so weeks.
Producers around the world had ramped up production in anticipation of China’s reopening which everyone said, all the right people promised, would be gangbusters. Very quickly, however, it became apparent it was a total bust.
Oil prices softened, alarming everyone around OPEC. The group took a couple stabs at modest product cuts trying to rebalance the market back toward supply with little impact given China reopening and the economic slowdown (in reality) in the aftermath of global banking woes. It wasn’t until bin Salman hit upon the idea of unilaterally removing 1 million barrels per day from the world’s markets for as long as it took that the situation, price and supply fundamentals, shifted in his direction.
With so much less available, all the oil which found its way to Cushing, Oklahoma at the start of the year has since vanished, most of it disappearing during the past two months.
In macroeconomic terms, it doesn’t represent a change in underlying condition so much as confirming the previous set of circumstances – demand changed, demand had been destroyed forcing suppliers to react. And now that suppliers have, you better believe demand is going to and not at all in the way the Saudis are counting on.
They’ve clearly bought into the “soft landing” applying the narrative in wider fashion to the rest of the world. The Saudis are gambling bigtime that China will get its act together any day now, Europe will somehow avoid falling further into recession, and, most of all, that Jay Powell’s forecasting prowess has improved by an order of magnitude, maybe two.
Standing against them though not really betting the other side is the world’s businesses and consumers. An economy with more going for it rather than against might be able to take on the $90 or even $100 oil Riyadh has envisioned. Why on earth they didn’t take account of the 2022 example is a mystery in itself.
The last time crude flew and curves backwardated this much this fast, the result was a complete phase shift for demand, the very same which led to the predicament we find globally right now. That previous spike (two of them, one in March ’22 the other in May) unleashed more than enough demand destruction to put Europe into a shallow recession within months while thoroughly ruining China’s reopening.
But that’s just what oil shocks do. People have a mistaken impression of the Great Inflation, as if it was all OPEC’s doing. On the contrary, the very stagflation most remember was originally written nearly a decade before the 1973 embargo on the eurodollar system’s nearly unlimited ledger. When oil surged initially (and again in ’79), it was enough to put that inflationary economy into recession, briefly bringing about some modest relief from the price pressures as demand for everything including crude dropped sharply.
Modern history of energy-intensive economies is perfectly clear on this point, one we were just reminded of a year and a half ago. It put the global economy on the road to recession to begin with, so it only stands to reason this latest one merely finishes it off.
An example comes from the world of major food processing. Nestle’s outgoing CFO, Francois-Xavier Roger, told a conference audience just yesterday (reported by Bloomberg) that the world’s inhabitants are eating and drinking less. The total amount of food and beverages being sold has tumbled though revenues haven’t, not yet.
That’s not inflation, either, rather more seeds of recessionary demand destruction. Some companies have been passing rising costs on to their consumers who can’t afford them, so they have little alternative but to buy less. In terms of food and drinks, Roger says, “People are consuming less, or they’re eating less or they’re wasting less or they’re eating more out of home…”
It sounds like stagflationary impoverishment at first, especially once you consider how the most recent oil move is going to make this all so much worse in the short run. The inflation part of stagflation, though, means that companies can, do, and continue to pass along rising costs because there’s a surplus of money (through credit) running through the economic system. It goes from source to initial users then circulates and recirculates through additional credit, higher wages, business activities, etc.
The current period shows the opposite of those. To begin with, the cash grab from 2020 and early 2021 is long gone, and rather than having been recirculated through more organic methods it all went to the most unproductive places, like Riyadh, a gigantic cash migration from governments only temporarily through people and businesses (and the small banks who served them) then to be stuck in fruitless economic cul de sacs like some mega-retailers, goods shippers, and, most of all, the energy sector.
It was a windfall for them yet a dead-end for the economy thus the very notion of inflation. The only way to bring about some pricing power is to do what Abdulaziz has done and cut back even more on supply.
And that has meant people and especially smaller businesses have been left holding the macro bag. While they were in temporary possession of the cash, they could afford the supply shock price effect. With it being long gone, take Mr. Nestle here at his word.
Adding to the growing woes, banks aren’t leaning in to the nominal opportunity as their forebears had in the seventies; just the opposite. Credit is being cut as institutions are increasingly “deselecting” their customers, as it was put by one such Canadian depository, for loans. From Canada to Europe even the US, debt is drying up faster than at any point since 2011.
It isn’t Fed or ECB rate hikes, rather simple risk/return. Rates would argue for more credit supply as they once did in the late 60s and throughout the 70s, the real secret to stagflation. Bankers unlike central bankers only see risk here; on a higher risk basis, adjusting prospective returns by it means stepping back, especially in light of the prior major liquidity interruption the public has forgotten about which bank managers haven’t.
Against this backdrop, no wonder the dollar is once more surging. People understandably though incorrectly assume that’s because of the Fed and higher rates. No, there is little correlation (none outside the shortest run) dollar to policy rate targets or even differences between rate targets among various central bank regimes (rate differentials) and the behavior of the dollar’s exchange value.
As Valentina Bruno and Hyun Song Shin elegantly put it in 2013, “The focus on the US dollar as the currency underpinning global banking lends support to studies that have emphasized the US dollar as a bellwether for global financial conditions…” What that means, quite simply, the dollar’s bull is not inflation.
Right now, the greenback is back to rampaging against every major currency starting with the euro and China’s yuan (quite notoriously). Dollar providers throughout the eurodollar system are surveying the global situation and taking their “money” and going home (which doesn’t mean US markets). They are increasingly sitting out this next phase for what should be rather apparent reasons.
Appropriate then, if sad, Dollar General, the downscale US retailer, at the end of last month warned that it was having a very hard time selling the cheapest products, including food echoing Roger, to hard-pressed American consumers. Now imagine what that, Nestle, bank credit, all of it is going to look like with the oil prices the Saudis just bet everything on.
When you have friends like these…
