Forget Trump or Opec – here’s what really drives the oil price

Donald Trump © Getty Images
Neither Trump nor the Saudis control the oil price

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US president Donald Trump isn’t keen on higher oil prices.

He wants to be seen to be keeping them down – higher oil prices means higher petrol prices (that’s “gasoline” for our US readers).

Trouble for Trump is, it’ll take more than a few tweets to keep the price of black gold from rising further.

The politicisation of markets

Markets in general are increasingly politicised. By this, I mean that politicians increasingly feel that they have the right to intervene in the price-setting mechanism in an overt manner.

That’s what happens when you very visibly step in to save one powerful industry from the consequences of its own mistakes. By bailing out the banks in 2008-2009 and not imposing sufficiently visible penalties for that, the way was paved for the death of the consensus on free markets.

Those rules clearly only applied to the “little people”. And now the “little people” want to know why they should abide by those rules if the “big people” don’t have to.

Hence you have all this talk of MMT (money-printing for “the people”) and calls for the nationalisation or break-up of industries from utilities to technology.

Many (most, even) of the objections are entirely valid. The problem lies with the proposed solutions, which will mostly lead to even more chaos and value destruction.

There’s a chap called Ben Hunt who writes very well (and rather prolifically) about this stuff with his colleagues at Epsilon Theory – I recommend you check out his website. (But finish reading Money Morning first).

Anyway – that’s all a tangent to today’s main topic, although hopefully an interesting one.

I bring up politics because I want to talk about one of the most politically-sensitive markets in the world – the oil market.

If you’re a US politician, there are two prices in markets that you keep a close eye on. One is the level of the S&P 500; the other is the price of oil. Here’s why.

Americans care about the stockmarket the same way that the British care about the price of their house. If it’s going up, they are happy with the economy; they feel wealthier, so whoever is in charge must be competent. So if they’re a swing voter, they’ll likely go with the incumbent.

For oil, it’s the opposite. In Britain, petrol is quite highly taxed and so, while we see the effect of a rise in the price of oil, it’s not always glaringly obvious (and the pound/dollar exchange rate has an effect too).

But in the US, gasoline is lightly taxed. So a rise in the price of oil goes almost directly through to the pump price (there’s lots of stuff in the middle about refining too, but let’s keep it simple for now).

If it cost you $30 to fill your tank last year and it’s costing $40 today, you notice that. And you don’t feel happy about it – whoever is in charge must be an idiot. If share prices are falling too – well, it’s time to vote for someone else.

It doesn’t matter what Trump or Opec say

This is why Trump will be jittery about the oil price climbing to its highest level so far this year. The price of Brent crude jumped above $68 a barrel yesterday.

For today, the market reporters are blaming sanctions on Iran and Venezuela (whose production was collapsing along with its economy in any case). We’ve also seen production cuts from Saudi Arabia to try to prop up the price from last quarter.

There’s also been the worry about the state of the global economy, even although that strikes me as being a fear that was raised in part by the falling oil price (a good example of “reflexivity”, where investors assume something about the real world based on changes in market prices, and then behave accordingly, resulting in a self-reinforcing belief).

The question is: how high can prices go, given that you’ve got the shale producers pumping as fast as they can on the other side of that trade?

As David Sheppard reports in the FT, the US sees its “growing energy bounty as a key foreign policy tool.” The fact that the US could be energy independent (if it wanted to be) has also allowed it to use its dominance of the global monetary system (the fact that the US dollar is the reserve currency) as more of a weapon.

(This is not new to Trump – as the shale boom accelerated, Obama Barack was quite happy to use the dollar as a weapon too – but Trump has certainly embraced the approach).

So if Trump wants to cap oil prices, while Saudi Arabia wants to push them higher, then who wins?

I suspect that question is a red herring.

Trump cannot make shale producers pump more oil than they want to. If shale producers can make a profit, or need the cash flow, they will produce as much as they can, regardless of anything the president says.

As for Opec – the Saudis might want to prop up prices, but history shows that their ability to influence the price is, in fact, far lower than your average person believes. The collapse in supply from Venezuela is arguably more of an issue, and even then, it’s not the main issue.

What’s really likely to drive the oil price is the level of optimism investors feel about global growth. The fear that they exhibited at the end of 2018 has not yet materialised. Meanwhile, you have central banks U-turning across the globe and China deciding that there’s been enough financial discipline for now.

That suggests to me that the most likely direction for oil prices in the near future – regardless of input from Trump or Opec – is higher. You can play that in a number of ways – but I wouldn’t be desperate to sell my oil companies right now, put it that way.

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