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"The Upside Down" of Oil

“Stranger Things” was a Netflix blockbuster about a group of friends growing up in the 80s suddenly thrust into dealing with an alternate dimension call the Upside Down. This Upside Down looked like the real world but something was different and over time it became the antithesis of the world they knew.

In the world of oil and maybe specifically the world of OPEC it seems that we might be in the Upside Down. Just a mere year ago oil had rapidly accelerated to $120 a barrel and the panicked whispers of $200 a barrel was being viewed as more than a possibility. Russia has incredibly invaded Ukraine and Ukraine had just weeks of independence left before ceding to the Russia tanks approaching Kyiv.

The world had seen this before and experts were forecasting similar results that had transpired in Crimea and Georgia before that. Oil prices was the proof that we had entered a zone that the world was all too familiar with. Oil was the chess piece that could be moved around the board and access to oil and energy made the wealth of nations.

Ever since the 1970s OPEC, a cartel, represented the Arab exporting countries mutual interest around the world. Those interests are based on oil dollars but represent far more. In fact, a look under the hood reveals that Saudi Arabia, as the major player influencing through both carrot and stick the actions and reactions of the OPEC monopoly.

Without diving to deeply, through price and supply Saudi Arabia could keep control over the oil monopoly and price. In 2016, Russia was added to this gang to form OPEC+ and as we stated earlier in this piece Russia has a lifeline that is made of oil and all Russia moves today are dependent on the war machine fueled by oil. In fact, even still today the price of oil is the dominant factor in global GDP and global inflation.

So why this long-winded preamble to here? Did anyone believe that today, a year later, and a war still unresolved would see oil trading at almost 50% down or $70 or lower? And is it lost on most that $70 means a lot to the global economy and the unbelievable resilience we are witnessing in the US economy could be caused by the incredible and complex relationship between all the oil producers and consumers.

But as we take a closer look, things ultimately end “Upside Down” in the 1970s, the monopoly that was OPEC, effectively raised oil prices aby cutting production, creating an oil crisis. However, in response, non-OPEC countries pursued new sources of oil and the result was “upside down” for oil prices and OPEC as new oil supply came online. Making it worse, many OPEC members jumped ship and sold even more oil, particularly to combat the loss of revenues. And as if it could get more “upside down”, Saudi Arabia flooded the markets with even more oil to punish all who defied them. The result was a glut of oil and quite lower oil prices. Quite the opposite of the purpose of the oil “cartel” OPEC.

The direct result was growth in developed countries and economies as all boats rose on the nosedive of oil. You might be seeing what we’re getting at today and the parallels. The addition of Russia to OPEC was another attempt to monopolize the supply of oil and swing the power back to oil producers as opposed to buyers. You can’t blame them as big new buyers like China create new demand for oil and to some extent no end to that demand.

But again we enter the parallel universe of the Upside Down. This time we have the defection of OPEC+ member Russia who inexplicably thought they had pocket ACEs but in reality they had pocket 4s as they played out their Ukrainian Gambit. Correction, Putin played his Ukrainian Gambit. Despite the early onset of $122 oil, the combination of rising Russian oil production, International sanctions and price caps, oil now trades at $70 or below. All this broadly translates into at least a 65% drop in Russia’s oil and gas revenues.

Clearly this can’t be what Putin expected after the early days of the Ukraine invasion. He’ll find it hard to fund a war at this point forgetting the cost of human life and the political capital he must be burning through. Here is were the rest of us enter into the Upside Down, imagine a 4th dimension where certain “cost of goods” drop by 50%? Imagine no more, as seen by the chart below and it’s quite possibly this affect that supports the current economic resolve in GDP and employment level. Lower PPI is great for consumers and may explain the ongoing strength in the US consumer and thus the US economy.

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