đLet's talk about oil.đ˘ď¸
Its price will likely stay elevated for longer. This will hurt everyone. But the US may be a relative winner. The next forced asset rotation cycle is looming. All the money back to America?
I have a rule: Donât write about the latest events in geopolitics, esp. with Trump in power. Things usually move so quickly that you might look like fool faster than your readers can open your email. Occasionally, I digress from that rule. I regret it more often than not.
In my opinion, there is one safe conclusion to make one month into the Iran escalation: Oil prices will likely stay elevated for longer. Even a potential quick resolution wonât change that. Itâs the appropriate base case to work with. There are several additional conclusions downstream from this base case. This article will dive into which ones.
TLDR Summary
We wonât go back to $60 oil even if the Strait of Hormuz situation resolves quickly. Risk premia will remain at normal or above-normal levels for the foreseeable future. The complacency of 2025 will not come back.
The global economy has benefitted from that complacency. Low energy prices have supported economic activity and avoided recessions where they would have otherwise occurred. Now, higher energy prices will hit the global economy and oil importing countries will be hit hardest.
Theoretically, the US is shielded from global supply shocks because they produce more petroleum products than they consume. However, they are deeply integrated into global energy trade. They are exporting half of their production because they lack appropriate domestic refining capacity. Therefore, American consumers canât be shielded with protectionist measures such as export controls.
Protectionism is not needed to save them though. American petroleum producers might generate $300bn in extra profits this year as a windfall gain from the global supply shock. Itâs a huge amount, about 1% of GDP, that could be redistributed via taxes to consumers should high energy prices force them to their knees.
The US is not nearly as vulnerable to exogenous energy price shocks as they were in past recessions. Other jurisdictions canât say the same. China, the EU, Japan and IndiaâŚthey are all massive oil importers with very limited domestic production. Their economies will do very poorly should oil prices stay elevated.
Investors donât seem to pay attention to that risk. They are heavily invested in the EU and in emerging markets and they are underweight US Dollar and US assets in general. The next forced asset rotation cycle is looming. All the money back to the US?
More similar content from Fallacy Alarm
1. Oil prices will likely stay elevated for a while.
Last year in June, I published the article below on the energy sector.
At that time, the sector was heavily underweighted by institutional investors and ignored by retail investors. This bull market is driven by innovation in software and semiconductors. I argued that energy is a risk-off sector in that environment. You bet on it when you want to bet against productivity gains in the darling industries.
Energy doesnât participate in the hottest innovation themes of our time. Itâs a hedge against their failure. Investors pay for that insurance through an inferior return during good times. But the more hate energy gets, the more overextended the bull market in other segments likely is and the more attractive the hedge becomes.
But there is more to the underweight in energy than this investor allocation arithmetic.
