Episode 15 – Energy Prices on the Eve of the Election

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Welcome to Market Perspectives, a Mercer Advisors podcast. Today’s episode is energy prices on the eve of the election. And we’re going to be taking stock of what’s happened with gas prices, oil prices, and other energy sources too over the past four years. I’m Josh Zumbrun, Director of external communications here at Mercer Advisors. And I’m joined by Don Calcagni, our chief investment officer. Don, good to have you with us.

Hello, Josh. Thank you. It’s great to be here.

We wanted to talk about energy right now because it’s such a topic of conversation around the election. A lot of people have been conditioned to think about energy prices as a referendum on our political system. Now, one of our key takeaways here is going to be caution against an overly simplistic take on what’s happening with energy prices. But we’re going to build to that. So Don, to start us off, let’s just take stock of where energy and gas prices are.

Just to step back, if we were to look at gas prices today, they’re up about 22% from where they were in January of 2020. Now I’m highlighting January of 2020, Josh, as a baseline that was right before COVID. Certainly, a lot happened with gasoline and oil prices.

Prices went haywire.

They went absolutely crazy. You can’t really talk about gasoline without talking about oil and vice versa. Our citizens don’t typically purchase barrels of oil. We purchase gasoline, though, every day.

The two are highly correlated, but they’re not exactly the same. There’s a lot that goes into the price of a gallon of gasoline. Everything from the price of oil, but also refinery capacity, as well as state taxes. One of the biggest inputs in the variability of gas prices throughout the United States are the state level taxes.

I live in Pennsylvania, which has some of the very highest gasoline taxes in the country. So gasoline tends to be fairly expensive here relative–

Whatever it is nationally, it’s a little higher in Pennsylvania, California. It’s lower in the South.

But the trend is similar everywhere. And what is it exactly?

Yeah. We’re up about 22% since January of 2020. Oil prices are up about 16% since January of 2020. Now I think it’s important to highlight, Josh, that oil prices bottomed in April of 2020.

In fact, for one day in April of 2020, oil prices were actually negative. I think it was like negative $25 a barrel. Just to show you how crazy things got. And oil prices were pretty low throughout 2020 because the global economy effectively collapsed.

However, by the end of the Trump administration, oil prices were still higher, about 8.5% relative to when Trump entered the White House. So I just think that’s an interesting reference point. Under Joe Biden, prices for oil actually rose about 16% under the Biden administration. So just an interesting point of reference.

Now what have been the drivers? Like why has there been so much volatility in energy prices these past few years? Especially now, we have the benefit of hindsight, where we’re looking back at a lot of this era and can have a clearer perspective on what occurred than when we were living through it.

Well, the reality remains that naturally, COVID had a significant impact on global energy prices, specifically oil and gasoline. As I highlighted, oil prices were briefly negative in April of 2020. So COVID naturally had a massive impact on energy prices. Fast forward to 2021, vaccines became widely available.

And certainly all of this pent up demand in the US economy was unleashed. So people suddenly started going on vacations again, Josh. They’re driving to the New Jersey shore. They’re doing their cross country trips.

So the demand for energy began to rise throughout 2021. And then in February of 2022, Russia invades Ukraine. And oil prices spiked quite violently in response to that. If you remember, there was also the sabotage of the Nord Stream pipelines in the Baltic Sea area.

And so that also had an impact on helping to push up the prices of oil, gas, natural gas, things like that. Since then, supply chains have largely stabilized. So despite Western sanctions on Russia and so on and so forth, we have seen global supply chains readjust to that. And we’ve actually seen deflation in energy prices here over the past six months.

It’s remarkable if you look at the chart of prices over the past five years. That right when that invasion of Ukraine hits, the gas price spikes up. And you see it start to come down pretty quickly. And like when you’re living through that and gas was $5 a gallon nationally that summer, obviously like we said, higher in some places, you lose track of what the drivers of it were. But when you look at it retrospectively, it’s remarkable how clear the timing is from that invasion, the Nord Stream disruption to the spike. And then you see it gradually fading ever since. What drove that actually is much clearer now than, I think, it was when we were living through it.

It’s clear in hindsight. And certainly we’re dealing with an election season at the moment, and there’s all kinds of soundbites out there around these things. But the reality is, Josh, you rightly point out, if you just look at a chart of oil prices over the past five years, it is shocking to see how it spiked in response to Russia’s invasion of Ukraine and has since slowly come back down to normal.

So things have come back down to normal. But like you said at the beginning, when we look at it, it’s about 22% higher than it was in 2020. So obviously, there’s something that’s lingered that has kept energy prices higher. It’s not like it’s only Russia happened and that’s over now and things are back to normal. That’s not the case. It is higher. And so what do we point to for why we’re still higher two years after the whole disruption from Russia invading Ukraine?

Well, Josh, we’ve had broad-based inflation throughout the entire global economy over the past two to three years. And if we actually just look at what the inflation has been, when you look at the consumer price index over that period of time, what we observe is that the consumer price index inflation has actually risen about 22%. So everything from groceries to rents to the price of automobiles and car insurance and things like that, we’ve seen broad-based inflation of about 22%.

So when you look at the price of oil through that lens, especially considering that oil is a critical input in so much economic activity, to see that oil is 22% higher, it really isn’t a surprise. In fact, it would actually be a surprise if oil had not gone up 22% when everything else did. And so I think the real question is, really, what has been driving this broad-based inflation? That’s a slightly different question than what you’ve asked. But the reality is oil has risen pretty much in tandem with the consumer price index over the past several years.

Yeah. It’s probably not the way most people think about it. But you could say that adjusted for inflation, the gas price isn’t the thing that’s moved. The gas prices just kept in place.

And so the question becomes, OK, well, what were the drivers of this inflation then? Maybe this isn’t primarily a gas story. It’s an inflation story. And so then what is the inflation story?

Certainly economists are going to be debating that for the next 100 years. Really, where did this inflationary spike come from in 2021, ’22, and ’23? And I think it’s important to keep in mind that prices rise for two reasons. There is both supply and demand. And it’s the intersection of the two that ultimately sets the price in the marketplace. And so on the supply side, during COVID, we saw the global economy totally shut down. So lots of supply evaporated from the marketplace.

Just think of China. Think of Prime Minister Xi’s zero COVID policy in China. China is the world’s factory floor. And you had now the world’s largest producer of manufacturing goods totally shut down. That logically removed a ton of supply for goods from the marketplace.

That by itself would push prices higher. But on the demand side, what we also saw happen, certainly by the end of 2020 when vaccines became more widely available, is all of this pent up demand hit the marketplace.

Remember, Josh, the global economy effectively shut down. It shrunk dramatically during the first three quarters of 2020. That demand didn’t go away. It was bottled up.

I remember my wife and I calling DoorDash. And suddenly once the vaccines were available, we were going out to eat almost every night because we just missed actually going out in public. And so all of this pent up demand hit the market at the same time when supply had shrunk dramatically. Now layer into that government spending.

Under the Trump administration–

Stimulus cheques

Massive stimulus under both the Trump administration and the Biden administration. I know right now they like to point fingers at each other, but the reality is both administrations, rightly in my view, approved very significant stimulus packages. Now we can debate in hindsight were those things good or bad and to what extent did they contribute to inflation.

Were they the right size? Were they the right timing? Yeah.

[INAUDIBLE]. Were they targeted appropriately? But I think we also need to remind ourselves that for a period there during 2020, and even into early 2021, we were looking into the abyss of a major deflationary spiral. And at least in my judgment, I think the Federal Reserve and federal government actually did a fairly decent job making sure that the global economy, and certainly the US economy, did not collapse.

A lot of us just worked from home during that period, but a lot of people also just had their job and their income completely disappear in those early pandemic months. And if nothing had been done, it would have been potentially, people say, a depression level event. And you can see why it would have been if there wasn’t support for people whose job completely went away.

It absolutely would have been a depression level event. Let me just give you some statistics. In the second quarter of 2020, the US economy shrank at an annualized rate of 33%.

That is a lot higher than how much the US economy shrunk in 1930, during the Great Depression. So it would have absolutely been a depression, on par even exceeding what we saw during the Great Depression. Not to alarm our listeners. But thankfully, we actually responded.

Now, again, we’re going to debate for the next 100 years. Was it too much? Was it not targeted enough? But the reality is, back in April of 2020, we didn’t know exactly what we were dealing with in terms of the pandemic. We didn’t know how long this was going to last. And so it’s easy, with the benefit of hindsight, to determine what we should have done, to argue what we should have done or should not have done. But at least at that moment in time, it seems like it was the right solution.

And when it comes to inflation, the timing of the reopening is really important. Like in 2021, the US economy was opening in a major way, whereas China was still trying to keep a situation where there was no COVID in the entire country. So you had the world’s biggest economy opening up, while the world’s second largest economy, which is also the big producer, is still completely shut down. And so you just have a mismatch for the ages.

One of the biggest failures coming out of COVID was clearly our leaders inability to coordinate, not just within the United States, among the states and the CDC, but also was a failure to coordinate globally with other countries a response. Viruses naturally don’t stop at country borders. In terms of the global response, it was very uncoordinated. And I think what you’re highlighting is probably one of the biggest missed opportunities to better coordinate our economic activity in response to the pandemic.

Another thing we talked about when we were thinking about this topic was we often look at inflation as sort of a US phenomenon. But in fact, we saw this inflation, it’s hard to peg on US policy because you saw it almost everywhere in the world.

You know, absolutely. And I know that we often hear allegations that it was US government policy, perhaps, that led to all this inflation. I don’t think that really holds a lot of water, Josh, for the primary reason that you just cited. This inflation has been a global phenomenon. We’ve seen inflation in China and India and all throughout the emerging markets and in Western Europe. And so to think that somehow the inflation of the past few years was somehow just isolated to the United States certainly is just not true. So it was certainly very much a global phenomenon.

I think another question that a lot of people have when they look at what’s happened with energy prices is they say, well, was the US just not producing enough oil over this period? To what extent is there an answer where we just need to ramp up oil production? And if we did that, it would really help moderate the price increases that we did see.

Well, again, this is where data is actually really important. So if we actually look at US oil production, it’s actually been expanding quite dramatically since the global financial crisis in 2008, 2009. So over the past 15 years, we’ve seen US oil production expand dramatically. Just over the past five years, Josh, US oil production has increased by 18%. That puts us today at producing about 22 million barrels of oil daily.

We are by far today the world’s largest oil producer. The Saudis produce about 11 million barrels per day. So if you just think about that, we produce almost twice as much on a daily basis in oil as do the Saudis. So the US, by any objective measure when you look at our energy production, we are by far the world’s leader.

There’s lots talk about Russia, given the sanctions in response to their invasion of Ukraine. Russia today produces about 10 million barrels per day. We produce more than twice the amount of oil, as does Russia. Every year from 2021, ’22, ’23, and ’24 year to date, every single year, the United States has increased how much oil we produce on a daily basis. And today, the United States is indeed energy independent. We produce more oil on a daily basis than we consume as an entire nation. So we are effectively a net exporter of oil in 2024.

And this has been a trend, like you said, since the financial crisis. It’s been a 16-year trend that’s been intact, regardless of the political situation.

Correct. It’s very much a secular trend that, to your point, cuts across administrations. Josh, I made this point on our capital markets update call yesterday, is that as investors, as citizens, when we’re thinking about these economic issues and when we’re thinking about markets, candidly, we should look past administrations. We should look past political parties. Because at the end of the day, what is clearly true when you look at American economic history is that we have the best economic system in the world. It’s not perfect. I will never make a claim that it is perfect.

But when you think of the innovation in technology and in so many different areas of the US economy, US economic muscle, I still believe, is really unrivaled. And when you look at the expansion of our energy production over the past 15, 16 years, a lot of that has been driven by hydraulic fracking and things like that that have made it really cost efficient for us to produce more energy here at home. And so at the end of the day, I don’t see where political administrations candidly have a significant impact on energy production, markets, or the broader economy.

In our previous episode, we talked about the idea that investing and politics don’t mix. That it’s a mistake to take your political beliefs and think that it’s going to have an easy guide to how you ought to invest. You ought to try to separate those sort of things. And we said on that podcast–

we said, look, we’re not a politics podcast. We’re not here to tell you how to vote. It’s exactly the case here. Not trying to tell anybody how to vote.

Just making the point that when you look at this issue in any level of detail, it’s really hard to draw a story that says, oh, this is primarily driven by political outcomes. That as investors, as people watching financial markets, we want to try to separate what we think politically from our understanding of what’s happening in markets.

Absolutely, Josh. This is why I think it’s so important to focus on the data. Look at the data and understand the economic intuition, the economic relationships that are behind that data. As the United States has expanded and really innovated in the technological realm, our ability to do things like hydraulic fracking, the economics of energy production in the United States naturally began to change. And the Saudis and OPEC specifically have tried overproducing over the past decade in an attempt to push the marginal producers of energy in the United States out of business.

Guess what? It really didn’t work. And that’s because technological innovation has really pushed down the marginal cost of producing energy in the United States. It’s very cost effective for us to drill here in the United States because of the technological innovation. So that technological innovation cuts across administrations. It’s unrelated to any political party being in control of government at any one time.

I think that’s a great thought to leave it at. Thanks for joining us. Special thanks to Don Calcagni for his insights. If you’re already a Mercer Advisors client, feel free to reach out to your advisor with any questions about your portfolio. And if you’re not a client but would like to learn more, visit our website, merceradvisors.com. Until next time, this is Market Perspectives.

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