Monday, March 28, 2022
It’s too easy to blame the war in Ukraine for rising food and energy prices but they were rising before the crisis began. That said, the conflict certainly hasn’t helped. In Canada, annual inflation came in at 5.7% - the highest rate since August 1991. (1)
Fitch Ratings expects Eurozone inflation to average 5% in 2022 and sees potential shortages and energy rationing in Europe if there is an abrupt halt to the energy supply from Russia. Despite attempts by some European governments to cut back on Russian oil, it’s not easy to switch without causing a major disruption to their economies. U.S. exposure to Russian energy supply is much lower but the rise in world oil prices is adding to what was already a growing inflation problem. Fitch expects U.S. inflation to peak at 9% and average 7% for the year as a whole. (2) ;
That said, the markets have staged an impressive rally over the last week despite this negative news. The S&P 500 was up 1.83% and the NASDAQ ended the week up almost 2.4% while the S&P/TSX was flat. It is somewhat remarkable, given the U.S. Fed’s recent raising of interest rates and market expectations for many more rate increases this calendar year.
The price of oil fell earlier in the week as the European Union shied away from banning Russian crude imports and Kazakhstan reported that the disruption at a key export terminal was set to ease. Then, oil prices headed higher towards the end of the week as the EU continued to debate how to decrease its reliance on Russian exports and Saudi Arabian energy assets came under attack. Yemen’s Houthi rebels claimed responsibility for a series of attacks on Saudi Aramco facilities, including an oil storage facility in Jeddah. This attack is likely to cause some short-term operational disruptions, and may temporarily reduce Saudi supply.
Both the U.S. and U.K. have moved to bar Russian oil and many energy firms are also doing the same. China and India appear to be making up for this loss and Russia is aiming to ship the largest amount of its oil in almost three years next month. (3)
Geopolitical risk, like inflation, will not go away soon. What was a trickle of international companies pulling resources out of Russia is now a veritable torrent. Steep sanctions designed to isolate the Russian economy are now in full force. Whether that helps mitigate foreign policy in that part of the world remains to be seen.)
The theme of this update is clearly oil, oil and more oil. Energy is a huge global market that is influenced and impacted by many factors. Oil prices were headed higher before the invasion.Through March 22, the Putin premium only explains about 15% of the rise in oil and gasoline prices since 2021. The rest of the increase occurred before global markets had priced in the Russian invasion. (4)
Oil accounts for more than half the cost of gasoline, and gas prices rise and fall in tandem with oil prices. Or at least they should. In the US and Canada, gasoline prices seem to do nothing but rise while oil prices have been rising (and falling), causing some legislators to call out oil companies for taking advantage of uncertainty and “price gouging”.
From 2011 to 2014, U.S. oil prices averaged $95 per barrel and oil companies made sizeable profits. The resulting exuberance led to overproduction, and oil prices sank. From 2015 to 2019, prices averaged just $53 per barrel. Many producers continued to expand even as profits plunged as they expected profits to come later. In 2020, the pandemic struck and resulted in oil prices turning negative for a short time. The average price for the year fell to $39 and bankruptcies increased.
Texas law firm Haynes Boone has documented more than 600 oil and gas bankruptcies since 2016, with those firms defaulting on more than $321 billion in debt. This wipeout is displayed by the market performance of the energy industry during the last 10 years; it was the worst among 11 sectors comprising the S&P 500 index. From 2012 through 2021, the average gain on energy stocks was just 0.85% per year. The average gain for the S&P 500 index was 14.8% during the same time. In five of those 10 years, the energy sector was the worst performer out of 11. The worst losses came in 2020, when energy stocks fell 37% and underperformed the S&P 500 by 53 percentage points. (5)
Diversified sources of energy can’t come fast enough.
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