August 28, 2023

Two Key Variables

In 2022, I postulated that the price per barrel of oil would fall from ~$120/barrel to the mid-double digits. It proceeded to fall in the $60s over the course of the next year.

In making this postulation, there were two key variables:

  1. The strength of the U.S. dollar, which, when exceedingly strong, suppresses global demand for oil, as oil is predominantly traded in petrodollars.
  2. The rapid growth in U.S. oil production since the advent of shale oil production, sometimes called the shale revolution.

We can see these two key variables in the charts below:

The Dollar Became "Thrice In 50 Years" Strong In 2022

U.S. Oil Production, Buttressed By Shale Extraction, Soars In The 2010s & 2020s

Curiously, I have note seen these two variables, which are arguably the most important variables, discussed to any meaningful degree in the public discourse around energy prices, which have a very material impact on our rate of inflation in the the 2020s.

While our current inflationary period has often been likened to the inflationary period of the 1970s, these two key variables were perfectly inverted during that period:

  1. In the 1970s, U.S. oil production began to decline, which created the environment in which KSA's (Kingdom of Saudi Arabia) embargoes could spike the price of oil; thereby spike inflation by way of higher energy costs in the U.S.
  2. In the 1970s, the Nixon Administration decoupled the dollar from the price of gold, which caused the dollar to lose about a third of its value during the 1970s. Because the dollar and the price per barrel of oil are inversely correlated, this added to the inflation spikes that the 1970s American economy witnessed.

Today, the precise inverse of both of these key variables have played out, and this has served to put sustained, downward pressure on the price per barrel of oil.

And not just the price per barrel of oil: Natural gas prices, which account for a very large portion of U.S. energy consumption, have also seen exceptional downward pressure, contributing to an overall collapse in the rate of inflation.

The Price Of Natural Gas In U.S. Dollars

In short, these two key variables have served to suppress inflation quite dramatically, helping U.S. central banks to fulfill their dual mandate of stable prices and maximum employment.

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