Price Depends on Growth

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Last week, the geopolitical landscape in the Middle East remained relatively calm. While tensions persisted, Hezbollah (Iran’s proxy) continued to launch drone and rocket attacks into Northern Israel, and the IDF continued to expand operations in Gaza; no unexpected events occurred that could have led to a wider escalation of the crisis in the region. This allows us, at least temporarily, to shift our focus to other important subjects, such as the global energy market fundamentals.

The reason the Middle East crisis attracts so much attention from energy analysts is that any instability in the region has the potential to materially impact the supply of global energy. For example, take the possible interruption of the flow of ships through the Straits of Hormuz – this would immediately cause energy prices to climb sharply. However, barring any escalation in regional tensions (which appears to be the base case with a US presidential election a few months away), the supply of energy, particularly crude oil and LNG appears to be stable for the remainder of 2024 and into 2025.

On the crude oil front, we don't expect significant increases in production from any of the main producers during this period. The United States, without a new wave of investment, has largely maximised its crude oil production potential. We do not expect Saudi Arabia to change its current policy in the near term and produce and place more barrels on the market. Other producers are more or less producing at the maximum level possible since they are highly reliant on crude oil revenues. On the LNG side, it is clear that additional investments are being made around the globe, and we expect the world's largest LNG producers, the United States, Qatar, and Australia, to continue to grow production incrementally and progressively.

Accordingly, in the near term, energy prices will turn the state of global demand. Trend-based global economic growth will mean incremental demand growth, which will stress the currently stable or limited available supplies. On the other hand, flat or incrementally decreasing growth will create slack, resulting in expanding inventories and flat to declining prices. Thus, barring a geopolitical event for the remainder of this year and the first half of next year, the fate of energy prices lies in the state of the global economy – i.e., demand.

At present, large institutions, such as the International Monetary Fund (IMF) and the World Bank, project global growth to be around 3 percent in 2024 and slightly higher in 2025. In general, most believe that the global economy's trajectory will be based in large part on central banks policy. Over the past year, we have seen the major central banks, namely the US Federal Reserve and the ECB, raise rates significantly to combat inflation. The consensus is that for the remainder of this year and into next, both central banks will begin to ease policy as inflation subsides, and this will support economic growth. The problem of inflation, however, appears to be more stubborn than both central banks anticipated, and over the past weeks, the expected rate of cuts has been fading. While we, too, believe that central bank policy is pivotal to global growth, we are also concerned about another mounting problem. This is the problem of expanding government debt.

After the great financial crisis, when central banks took the highly unusual step of lowering rates to zero and, in some instances, negative, many governments around the world accelerated their deficit spending and grew their overall debt. With the cost of money at zero, why raise taxes? The prime example is the United States. At present, the United States has approximately $34.7 trillion dollars in debt (at this same time, in 2008, it had $11.5 trillion). Moreover, even though its economy is growing at a stable rate, it has been incurring additional debt at the rate of roughly $1.5 trillion dollars per year over the past several years. Undoubtedly, some of this debt was the result of government spending to support their economies during the COVID crisis. Nonetheless, COVID is now firmly in the rearview mirror, and debt and deficits continue to pile up. With interest rates the highest in the past decade, we are starting to see the impact of a decade-plus of excessive debt. Today, the U.S. government’s annual debt service payments exceed $1 trillion per year. To put this in perspective, The US government generally collects somewhere between $4.5 and $5 trillion per year in tax revenues and spends roughly $860 billion a year on defence.

The accumulation of excess debt around the globe, particularly in developed nations, will undoubtedly result in slower economic growth as governments will be required to redirect resources to debt service as opposed to investing in infrastructure and other social support. The long-term impact on energy demand is yet unknown but slower economic growth and less government subsidies will undoubtedly adversely affect overall energy demand.

It has been a long while since we have seen any of the major developed nations significantly increase the tax burden on businesses and citizens. The argument has been that increasing taxes will adversely impact growth and, therefore, lower (not increase) revenues. It seems that we are heading to a point in time where governments may have little choice but to raise taxes and revenues to support both their priorities and debt service. On the other hand, central banks may once again cut rates to stave off an economic crisis, but this time, it will be much more difficult with the spectre of inflation continuing to hang over their economies.


More: Market Updates, Crude Oil, Electricity, Geopolitics, Natural Gas


Richard Soultanian