Edited by Manasa Kashi and Lathika V
Anish Das is a second-year economics student at the Jindal School of Government and Public Policy. His interests include capital markets, foreign policy, and public finance. He is currently a Content Writer at Arthaniti – JGU’s Economics Society.
The American Umbilical Cord
The US has historically been one of the greatest beneficiaries of a globalized economy. Increased international trade has meant increased production efficiency- specialization in production, access to larger markets, and greater prosperity across the board. Borrowers in the United States, especially the government, benefit from global capital markets that lend to the US at interest rates more favourable than what would prevail if borrowers had to rely exclusively on domestic American savings.
As with all good things, however, there remains a crater-sized caveat. A globally connected financial system and more fluid trade pipelines mean that other countries are heavily exposed to US economic shocks. It is an obvious offshoot of the US’s dominant position in global trade, financial markets, and the widespread adoption of the dollar as almost a fiat global currency.
In the aftermath of the 2008 US housing crisis, economic activity took a nosedive in half of all countries. The ensuing global recession resulted in a sharp drop in international trade, rising unemployment globally, and slumping commodity prices. In several countries, production is still well below what it would have been- had output increases followed pre-crisis trends.
The writing on the wall is clear. If the US suffers, so does the rest of the civilized world.
Present Day Barometers
You can look, but you’d be hard-pressed to find anything resembling optimism on Wall Street.
The S&P 500 [an index tracking the performance of the 500 largest companies listed on US stock exchanges] is down by nearly 11% (year-to-date)Businesses have been subject to inflationary pressures, global supply-chain disruptions, and a higher interest rate regime. The road ahead is fraught with uncertainty.
Of the 12 sectors comprising the S&P 500, all but one are in the red this year- energy.
After leading 2021's stimulus-fuelled bull market, the energy stocks have risen to the forefront yet again as the only sector with a positive return this year.
The XLE ETF (tracking the energy sector) is up by 35% over the last year- beating the overall market by a staggering 46%.
Energy stock performance is often a direct offshoot of a rearrangement in the geopolitical/economic world order. Since these stocks trade majorly off the price of the respective commodities (oil, natural gas, coal, etc.)- energy company earnings and profits often change dramatically with little to no prior premonition. As a result, they often do not move in lockstep with the broader market, as has been the case this year.
Energy Rollercoasters
Oil prices in the US ventured into negative territory on April 20th, 2020- plunging from $18 to -$37 a barrel, the first time in history such an event had occurred.
Energy markets took a nosedive in 2020, battered by the onset of the pandemic that resulted in widespread lockdowns and travel restrictions- leading to depressed demand and historically low oil and natural gas prices.
A lot has happened since. A cascading domino effect- initiated by economic recovery and spurred on by war, sanctions, and a shift in attitudes towards corporate governance- has led to a befuddling bull run in energy markets, running contrarian to the disarraying lows of the markets at large.
First, global economies- including the United States, started reopening rapidly. The accelerated distribution of vaccines led to a faster-than-expected reopening, releasing the pent-up demand for energy. Strong demand for crude oil, necessitated by the removal of travel restrictions, resulted in soaring oil prices.
The Organization for Petroleum Exporting Countries(OPEC) then decided to maintain previously-set quotas for production, leading to further asymmetries in demand and supply.
Production fell in May despite an increase in production quotas for its members]
Another major factor has been the Russia-Ukraine war and its far-reaching political and economic implications. The war has scrambled supply lines in ways that will not be reversed quickly or easily. Before Russia invaded Ukraine, the European Union imported roughly 4 million barrels daily of crude oil and refined products from Russia. To weaken Russia’s economy while simultaneously weaning themself off Russian dependence, the EU has imposed a partial embargo on Russian oil and banned petroleum product imports.
Russian Roulette
In the wake of numerous sanctions on Russia, the US has emerged as the primary player in the energy trade- especially with regard to the supply of natural gas, with far-reaching implications.
During the pandemic, US Natural Gas suppliers dug into their existing inventory rather than digging new wells to meet demand. Depleting their inventories has kept them afloat financially but has limited their ability to grow production- now that demand for fossil fuels is growing.
After Russia invaded Ukraine, there was immense pressure on the EU to reduce reliance on Russian energy. To help with that transition, the US decided to step up at a time when domestic natural gas supplies were 17% below the five-year average.
Despite low supply, the US has pledged to send 50 billion cubic meters of LNG to Europe annually till 2030. That would be about 1/3rd of the LNG it receives from Russia-it has now become the largest supplier of LNG to the EU.
However, as with all things, there is a limit on how much the US can supply.
Natural gas supplies have steadily decreased due to their exports to EU allies- worryingly, with a pessimistic outlook on potential replenishment.
The Federal Energy Regulatory Commission (FERC) has given the green light for constructing thirteen new LNG (liquified natural gas) terminals. On paper, this sounds great. However, a number companies have not started construction due to a combination of an inability to secure financing and concerns about commercial viability.
US producers are hesitant to invest in new projects due to uncertainties regarding future demand, amid a global shift toward cleaner energy and a Biden administration which has been increasingly hostile towards the fossil-fuel industry. They need assurance that there will be stable, long-term demand-not demand due to extenuating circumstances.
But as this debate over probable options rages, consumers will have to bear the brunt. As the foremost exporter of natural gas, there's just more demand for gas coming out of the US- pushing prices higher for the foreseeable future.
It is pertinent to note that oil has followed similar trends. As oil supplies tightened, prices rose, and revenues spiked for oil giants. [Brent Crude, the international benchmark for oil prices, is trading at over $100 a barrel]
The Befuddling Gymnastics of Energy Supply Curves
It is notable how reserved, oil-and-gas companies plan to be, concerning increasing production- and not due to unnecessary caution for excess supplies.
The U.S. Energy Information Administration has recently released estimates that U.S. crude oil production will only increase by 600,000 barrels a day in 2022 and then another 600,000 barrels a day in 2023- far below their 2018/19 levels.
There is a very pertinent reason why executives of energy companies have not taken advantage of sky-rocketing oil and gas prices by pumping up output.
They are no longer paid for doing so.
Previously, bonuses compensated executives for producing a specified volume of oil or gas, with little to no regard for the bottom line. Now, after years of losses, investors are demanding a revamp of corporate strategy- to focus on profitability, not growth.
The top brass no longer wants to produce as a priority, the focus is on returning cash to the shareholders.
Instead of chasing higher fuel prices by producing more, oil and gas company executives have reported that they will “use profits to retire debt, pay dividends and buy back stock”.
Though oil and gas production has risen from its lockdown troughs, it remains below pre-pandemic levels despite crude prices skyrocketing to about $94 a barrel, and natural gas more than quadrupling about $9 per million British thermal units.
Walking the Inflation Tightrope and the Looming Possibility of Global Recession
US CPI surged by 1.3% in June- hastened by an increase in energy prices by 7.5% on the month. With changing investor demands, uncertainties about future consumer demand, and by causality, limited production & storage capacity- all major players in energy are unwilling to make up for supply deficiencies to reduce inflation. Supply constraints are here to stay.
All eyes, therefore, are on the Federal Reserve to aggressively hike interest rates to cool an overheated economy.
President Joe Biden’s approval ratings have taken a huge hit (below 50% since August 2021) due to the pain at the pump. In response, he has, on multiple occasions, made it known that his top priority is to fight inflation.
It would not be too much of an over-reach to suggest that there is immense pressure on his administration to act and act immediately. The Fed must pull off the ultimate balancing act- cooling inflation to their target rate of just above 2% while simultaneously avoiding a US recession- a soft landing.
History, however, is not on their side. On the last five occasions when inflation topped out at above 5%, recessions have followed.
As it stands today, the US inflation rate is 8.5%. [Inflation eased slightly in July, yet remained close to a four-decade high]
One can only hope that the Fed will succeed. Otherwise, the global shockwaves of a US recession may yet be due for a devastating return.
Citations
Cohen, A. (2020, April 20). Oil plummets over 300% to almost -$40 a barrel in historic collapse.
Wang, H. E. G. (2022, June 9). S&P Global Commodity Insights. S&P Global Commodity Insights. https://www.spglobal.com/commodityinsights/en/market-insights/latest-news/oil/060922-opec-output-up-after-two-months-of-declines-but-quota-shortfall-grows-platts-survey#:%7E:text=OPEC’s%2013%20members%20pumped%2028.62,and%20Kazakhstan%2C%20the%20survey%20found.
Cahil, B. (2022, June 8). European Union Imposes Partial Ban on Russian Oil. Centre for Strategic and International Studies. https://www.csis.org/analysis/european-union-imposes-partial-ban-russian-oil
House, T. W. (2022, March 25). FACT SHEET: United States and European Commission Announce Task Force to Reduce Europe’s Dependence on Russian Fossil Fuels. The White House. https://www.whitehouse.gov/briefing-room/statements-releases/2022/03/25/fact-sheet-united-states-and-european-commission-announce-task-force-to-reduce-europes-dependence-on-russian-fossil-fuels/
Tubb, K. (2022, June 28). Biden’s Radical, Anti-Fossil Fuel Energy Policy Costs Americans Dearly. The Heritage Foundation. https://www.heritage.org/energy-economics/commentary/bidens-radical-anti-fossil-fuel-energy-policy-costs-americans-dearly
Short-Term Energy Outlook - U.S. Energy Information Administration (EIA). (2022, July 12). Https://Www.Eia.Gov/. https://www.eia.gov/outlooks/steo/report/us_oil.php
Dezember, R., & Grossman, M. (2022, May 24). Why Shale Drillers Are Pumping Out Dividends Instead of More Oil and Gas. WSJ. https://www.wsj.com/articles/why-shale-drillers-are-pumping-out-dividends-instead-of-more-oil-and-gas-11653274423
Hayes, A. (2022, May 28). What Is a Buyback? Investopedia. https://www.investopedia.com/terms/b/buyback.asp
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