The Best Cure for High Oil Prices Is High Oil Prices? Think Again | Anas Alhajji on Twitter Spaces with Sohaib Abbas

Key Takeaways

  • Historically, when we ended up with recessions it was because of inappropriate monetary and fiscal policies; it’s not oil prices on their own 
  • What does it take to break the 7 cycles that keep oil prices high?
    • Change in fiscal and monetary policy (within them) and several exogenous variables
  • People do not realize that renewable energy projects are not sustainable or renewable
    • Sunlight and wind are renewable, but the projects themselves are not
  • High oil prices lead to increased activities in the oil and gas sector which means increased demand for basic materials
    • These basic materials are shared with all other energy sources (solar, wind, etc.)
  • The Biden administration and European leaders do not understand the relationship between energy and environmental security
    • Environmental security requires energy security; it’s the balance of both 
  • If America starts curtailing export then we might see other countries doing the same which will result in a global contraction of world trade and contraction of GDP.” Anas Alhajji
  • There is a very limited substitution between renewable energy and oil in the United States, Canada, Europe, India, and China
    • According to OPEC, the amount that can be switched from oil to renewable energy worldwide is only 1,000,000 barrels over 30 years
  • China and India are buying Russian oil at a large discount (between $22.00 and $32)
    • Will the Gulf states (especially Saudi Arabia, UAE, and Kuwait) react, or are they are going to let it go as a one-time thing? 
  • There is a serious problem with diesel worldwide, it’s not only in Europe
    • Due to COVID-19, the whole economy moves on trucks, and those trucks use diesel 
  • The most important event in the next 4 weeks is going to be geopolitical
    • The 7 cycles are going to play out and unless something exogenous influences them, there will be another downward cycle

Intro

  • Dr. Anas F. Alhajji (@anasalhajji) is a well-known energy markets expert, researcher, and author of more than 900 papers, articles, and columns.
    • Anas Alhajji joins Sohaib Abbas on Twitter Spaces for a big discussion on high oil prices, the 7 vicious cycles that keep them high, reasons we cannot rely on renewable energy, and much more
  • Host – Sohaib Abbas (@sohaibab9)

Are High Oil Prices Always Followed by Recessions?

  • High oil prices alone do not cause lower economic growth
    • For the most part, all the problems related to oil and recession are political
    • No theory in economics fully explains how high oil prices cause a recession
  • In the roughly 7 years since 9/11, there was a very unique period in history
    • After the 9/11 attack oil prices spiked upwards
    • It was the only period with high oil prices, high economic growth, high income, lower taxes, declining interest rates, and a declining dollar
    • This example clearly illustrates that we can have higher oil prices and higher economic growth at the same time
  • Historically, when we ended up with recessions it was because of inappropriate monetary and fiscal policies; it’s not oil prices on their own 
    • “We cannot talk about oil prices alone and recession without bringing in the monetary and fiscal policy.” Anas Alhajji

7 Vicious Cycles That Can Keep Oil Prices High

  • 1st cycle: the oil price oil export cycle
    • High oil prices (like today) lead to an increase in government spending in oil-producing countries
    • The result is higher economic growth coupled with higher population growth (especially in poorer countries) 
    • This leads to higher domestic energy consumption (including oil), and lowers oil exports (e.g. investment declined in recent years)
    • Lower oil exports increase (again) or put pressure on oil prices 
  • 2nd cycle: the oil price natural gas cycle
    • High oil prices, high revenues, high spending, high economic growth
    • Increasing demand for energy but now due to the push to reduce emissions and carbon neutrality, it increases the demand for natural gas
    • The increase in demand for natural gas forces oil-producing governments to spend more on natural gas rather than oil
    • That means oil supply is not going to keep up with oil demand and that keeps the oil prices high
  • 3rd cycle: the oil price power shortages cycle
    • High oil prices, high revenues, high spending, high economic growth
    • Higher energy consumption, but if there is not enough power; the results are power shortages
    • To solve the problem of power shortages oil producers have no choice but to use more oil because it’s convenient
    • In some cases, they even use crude oil
    • The result is higher oil consumption, higher demand at the expense of net exports
    • Some countries (even though they are producers) do not have enough fuel oil so they opt for importing
    • Lower exports support high oil prices
  • 4th cycle: the oil price economic diversification cycle
    • By nature of the accounting system of the GDP in oil-producing countries, any increase in oil prices makes those countries more dependent on oil
    • To rebalance, they spend less on oil and divert the money somewhere else
    • That means less oil in the future; they cannot meet demands and that supports oil prices
    • Higher oil prices, and higher dependence on the oil sector in terms of money
    • Then they “…enhance the diversification policies which leads to divergent investment to other sectors that limits the production capacity and export and that supports prices.” – Anas Alhajji
  • 5th cycle: the oil price nationalism cycle
    • High oil prices, oil resources become more valuable, host governments ask for a bigger share
    • This is especially the case if they have joint ventures with international oil companies and they think that the foreigners are taking their wealth
    • Dispute starts, and the results are:
      • The production is halted or declined
      • It will stop the forthcoming investment
    • The outcome is insufficient production to meet demand and that supports oil prices
  • 6th cycle: the oil price social spending cycle
    • With high oil prices, citizens see the revenues coming to the government and they start asking for their fair share (support or subsidies)
    • The reaction of the government is to “crush” the insurgence by increasing government spending on social programs and security to defend the regime
    • Divergent of revenues to other things and higher oil prices to cover all extra expenses that support high oil prices
  • 7th cycle: the oil price limited investment observative capacity cycle
    • Undeveloped countries are getting a lot of money but cannot handle the investment
    • The choice is to send the money overseas (e.g. Russian assets being frozen)
    • They see the interest rate was negative and at 0
    • Should they produce more or keep that oil underground?
    • Historically, we have seen that some countries with higher oil prices prefer not to invest or expand production and keep their oil underground
    • This limits supply and pushes prices higher

What Does It Take To Break the Cycle of Really High Oil Prices?

  • Change in fiscal and monetary policy (within them) and several exogenous variables 
  • Megacycle- all seven cycles working together (supply-side) along with loose monetary and fiscal policy (government)
    • The seven cycles are perpetual and they keep feeding each other; they are not going to break by themselves unless something happens from the outside, e.g. real-estate bubble
    • “All the events that will stop those cycles or reverse them are exogenous events.”Anas Alhajji
  • Factors that cause problems in the economy and reverse the cycle of high oil prices:
    • A decrease in government expenditures
    • Increasing taxes
    • Increasing interest rate
    • Higher dollar
  • “If we end up with a situation where fiscal policy and monetary policy are all leading to contraction, then it’s a big problem for high oil prices.”Anas Alhajji

The Future Is About the Failure of Green Policies

  • Their impact on oil demand is going to be way lower than forecast
    • Regardless of the supply, the demand for oil and gas is going to be higher than forecast
    • All the talk about the increase in production within OPEC is based on the current demand forecast
  • “Everything we promised on the green side has some serious problems.”Anas Alhajji
    • There is a lot of misinformation regarding the requirements when it comes to fossil fuel
    • People do not realize that renewable energy projects are not sustainable or renewable
    • Sunlight and wind are renewable, but the projects themselves are not
  • 10-15 years in the future, we will have more demand for renewable energy
    • But everything built in the last 20 years will have to be replaced (trouble for investment decisions)

High Oil Prices on Their Own Are Not the Problem, It’s the Massive Volatility

  • High oil prices lead to increased activities in the oil and gas sector which means increased demand for basic materials
    • These basic materials are shared with all other energy sources (solar, wind, etc.)
    • The problem is that renewable energy did not experience the same profits as the oil industry
  • Higher oil prices are not going to expand renewable energy and the electric vehicles industry
    • We can’t simply switch because the cost of basic materials will increase for everyone

The Concept of the “Sweet Spot”

  • The calculation of the oil sweet spot requires about 90 variables
  • The basic principles of the sweet spot: 
    • It’s the price that makes consumers and producers happy 
    • It is the price that guarantees investment in the oil sector without killing the substitutes or the alternatives
    • The sweet spot changes all the time because it depends on several macro variables around the world
  • What will happen to the sweet spot when we enter the megacycle? Anas is not sure
    • In regards to today’s event and everything we know so far, the sweet spot remains within the 68-75 range

Cure High Oil by Banning Crude Exports Scenario

  • The Biden administration might attempt to cure high oil by banning crude exports scenario
    • It is possible, but Anas hopes it won’t reach that point
  • They do not understand the relationship between energy security and environmental security
    • Environmental security requires energy security; it’s the balance of both 
    • Fighting climate change requires long time efforts and policies – this is something they must understand
  • By tilting the discussion to one side and tilting all the spending to one side we lost both we lost in environmental and energy security
    • If the United States starts curtailing export then we might see other countries doing the same which will result in a global contraction of world trade and contraction of GDP.” Anas Alhajji

Reasons We Cannot Relly on Renewable Energy

  • There is a very limited substitution between renewable energy and oil in the United States, Canada, Europe, India, and China
    • Renewable energy is used to generate electricity, and in those countries, a very limited quantity of oil is used to generate electricity
  • Even if they double renewable energy, it has no impact on all demands 
    • According to OPEC, the amount that can be switched from oil to renewable energy worldwide is only 1,000,000 barrels over 30 years
    • According to Anas, it’s possible to go up to 2,000,000, but that’s still insufficient
  • The problem of transportation 
    • What is the impact of electric vehicles on future oil demand? 
    • “Electric vehicles will reduce the growth in all demand, but will not reduce demand itself.” Anas Alhajji
    • In the next 50 years oil demand will continue to grow, but at a lower rate than in the past

Ukrainian Crisis and the Attacks Against the Saudi Oil Production Facilities

  • If you have a market panic, releasing all from the SPR is not going to help
    • Lifting sanctions on Iran or Venezuela is not going to help
  • Panic needs to go away before adopting new policies
  • Focus on what is next when it comes to the macroeconomy of various nations 
    • Are we heading for a recession and lower economic growth? 
    • Should OPEC, OPEC plus increase production or not? 
    • Are we going to lose some Russian oil? 
  • Political chaos in some countries could be the name of the game
    • Higher fuel prices and higher food prices have resulted in protests in several countries
    • Some of these countries are also oil and gas exporters
    • That means that oil and gas exports are going to stop
  • We are going to see increasing prices as an indirect result of the conflict in Ukraine

A Huge Oil Spike in Price Leads to a Huge Drop in Price?

  • Historically we have witnessed that after every huge oil spike in price there is another huge drop in price
    • Does this still apply in 2022?
  • This is the nature of the oil industry
    • If every one of those cycles works together, they will maintain the megacycle for a long time until something exogenous happens 
    • Like we’ve seen in 2001, or 1991, something outside the realm of the industry itself
  • Generally speaking, when we talk about political events in oil-producing countries, all of them happened during periods of high oil prices 
    • When Putin invaded Ukraine for the first time in 2014, it was during high oil prices 
    • Now it was during high oil prices in 2022
    • Big major political events like we are seeing now in Ukraine might break all the cycles

What Will China Do? 

  • China and India are buying Russian oil at a large discount (between $22.00 and $32)
    • Will the Gulf states (especially Saudi Arabia, UAE, and Kuwait) react, or are they are going to let it go as a one-time thing? 
  • “If China and India pivot to Russian oil at a discount, will the Gulf oil be going to Europe and America at world prices, or is there going to be some sort of arbitrage?” Anas Alhajji
    • If they do that, there is no guarantee that China won’t do the same and sell Russian oil to the rest of the world
    • They buy it at $80.00 from Russia and then ship it to the rest of the world at 100 or 120
    • We already saw China storing oil and strategic petroleum reserves to manipulate prices 

Europe Has 40 Days of Diesel Left

  • Everyone is focused on gas but what about diesel?
    • Diesel prices are way higher than gasoline prices
  • There is a serious problem with diesel worldwide, it’s not only in Europe
    • Due to COVID-19, the whole economy moves on trucks, and those trucks use diesel  
  • Historically we’ve experienced similar situations, but not to this extent
    • Usually, refiners were quick to react
    • The problem is that environmental regulations limit the choices of refiners when we move between seasons
    • When the crashes hit (e.g. switching to summer fuel), we might end up with serious problems according to Anas

Advice for the Young Generation of Petroleum Engineers and Geologists 

  • There are massive opportunities for petroleum engineers and geologists in the future
    • The oil industry is a cyclical industry and a double major is a must
    • They need to take more risks; if you are in North America, you can buy a couple of oil wells and start your own company
  • There is great demand for engineers and geologists in North America
    • It’s a great opportunity for people from the Middle East, Africa, and Latin America to come to America

The Next Four Weeks Are Going to Be Crucial

  • The most important event in the next 4 weeks is going to be geopolitical
  • The 7 cycles are going to play out and unless something exogenous influences them, there will be another downward cycle
  • If nothing breaks the cycles, this is going to last for a long time
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