Written by our Director of Equity Advisory, Jeremy McKeown, the HyperNormalTimes provides in-depth and considered long-term commentary on major macroeconomic and market-shaping themes.

September 25, 2023

Higher For Longer – Oil & Rates


Measures of inflation have fallen, but they remain above target levels, and the recent sharp oil price increase is a concern. Recall that this inflationary cycle began with rising energy prices and diesel shortages in 2021. Central banks remain nervous, asking themselves if it is disinflation that is transitory. Despite the rate pauses, they will keep monetary policy tight for as long as possible. As Huw Pill, the Bank of England Chief Economist, recently described things, the forward rate path will be more like Table Mountain than the Matterhorn.

Central banks use monetary policy to control inflation, and OPEC+ uses supply management to control oil prices. Oil is the foundational benchmark for other energy forms that underpin all advanced economies. Last week, 15,000 delegates from over 100 countries gathered in Calgary, Canada, for the annual World Petroleum Council (WPC), the Jackson Hole for oil. The largest and most visible contingent was from Saudi Arabia, the world’s swing producer. Saudi’s energy minister, Prince Abdulaziz bin Salman (ABS), Crown Prince Mohammed bin Salman’s (MBS) half-brother, is OPEC+’s equivalent to Jay Powell.

In his speech to the WPC, ABS explained that the desire to manage oil price volatility was in the long-term interests of both oil producers and consumers. OPEC+ tell us that they have everyone’s interests at heart, claiming that its conduct is equivalent to central bankers controlling inflation. But, there is a widening policy divergence between the oil-consuming nations and the producers. While the IEA reiterated that global oil demand will peak before 2030, Saudi Aramco’s CEO openly accused it of being politically motivated and misleading. China, meanwhile, is happy to leverage its position as Saudi’s largest oil customer in attempts to decouple global oil from the US$.

But the US dollar remains the unit of account for global debt, and as the dollar index (DXY) rises (up 5% in the last eight weeks), our financial conditions tighten. Indeed, overall global liquidity measures stagnated in Q3, creating headwinds for most equity markets outside the US.

Within the US, liquidity and the US Treasury market have benefitted from two one-off boosts. The first was the prolonged drawdown of the Treasury General Account ahead of the Federal debt ceiling deadline, while the second derived from draining the Fed’s reverse repo facility. The reverse repo facility is a stored-up “battery” of liquidity leftover from the COVID stimulus measures now being drained by heavy Treasury Bill issuance. This liquidity battery has only a few months of charge left. Liquid headwinds will likely prevail as the US enters its election year.

While monetary policy drains liquidity reserves, US energy policy has drained its oil tanks, or Strategic Petroleum Reserve (SPR). Following releases of resources, the US SPR has just 350m barrels remaining, half the amount of a decade ago and 17 days’ supply at current US consumption. Critically, lower oil inventories and a foreign policy aim of reconciling the Saudis with Israel have lessened Washington’s leverage over pump prices as it approaches election year.

Since early Summer, OPEC+ has used its enhanced position to engineer a 25% oil price increase via just a 1-2% supply reduction, value-enhancing for large oil producers like Saudi Aramco. Unsurprisingly, the $2.5tn valued Aramco is now considering a share offering to fund Saudi Arabia’s ambitious economic regeneration plans. The suggested $50bn sell-down would represent only 2% of Aramco’s equity in what would be the World’s largest-ever equity capital markets transaction.

If this deal were to happen, China would be the first investor in line. As Saudi’s most significant oil customer, it is trying to recruit Saudi Arabia into its BRICS family of nations. Furthermore, owning a slice of Saudi oil reserves would be seen as an attractive alternative to its portfolio of US Treasuries. (A 2% stake in Saudi Aramco would be worth about 6% of China’s current US Treasury holdings without giving up much yield). Politically, this would enable Aramco to bypass a Western market listing and further provoke the UN human rights challenge looming against it and its banking advisors.

We will have to endure structurally higher inflation and interest rates for several years. Combined with multi-decade low oil inventories, this is a fragile investment environment that the world last saw in the late 1970s, which most of today’s investors did not experience.

A broad spread of asset types helps mitigate the cocktail of potential consequential risks from this setup. High-yielding assets, value equities, and tangible real assets are all components of a durable portfolio. But once the tanks of oil and dollar liquidity are drained, meaning the supply of credit and oil remain tighter for longer, exposure to energy and value equities, ideally income-generating, becomes a greater priority for all investors.


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