Marko Kolanovic Asks ‘How Cheap Is Oil?’

For the past couple of months, the Biden administration has been at pains to articulate a plan for reining in gas prices.

Whenever Americans pay “too much” at the pump, there’s a tendency to assign blame. The implication is that something is amiss and that somebody, somewhere needs to “do something about it.”

Not one to shy away from publicity or to eschew grandiose gestures in favor of quiet back-channeling, Donald Trump periodically took to social media to blame OPEC for price spikes and to demand the Saudis remedy the situation posthaste under threat of unspecified punishment.

The Biden administration doesn’t generally conduct foreign policy on Twitter nor is this White House particularly keen on unilateral action, which is why US officials have spent the last few weeks attempting to coordinate a reserve release with other nations. On Monday, reports suggested Biden could announce an SPR release as early as Tuesday in tandem with India, Japan and South Korea. China is also involved.

OPEC and allied producers have been reluctant to stray from an existing plan to gradually increase output. Riyadh insists an incremental approach is prudent considering ambiguity around the pandemic. Given the persistence of the virus and the possibility that new waves could force major economies to reinstitute strict containment measures, some producers argue it’s premature to assume demand has stabilized for good. I’ll just leave aside the self-serving nature of those nominally plausible excuses.

This debate is playing out at a time when the US is dealing with broadening inflation and the world is coping with an acute energy crunch that’s manifested in anomalous price spikes for coal and natural gas. Gas-to-oil switching served as a further boon to crude prices, exacerbating an already contentious dynamic between Washington and Riyadh. There were indications on Monday that OPEC could respond to any reserve releases by adjusting their output plans.

Read more: ‘Turbulence All The Time’: A Never-Ending Energy Crisis?

So, how expensive is oil considering the competing dynamics mentioned briefly above?

Commodities analysts will happily quantify that for you. For example, Goldman wrote that the recent pullback in crude prices “far overshot the actual fundamental risks” associated with a new COVID wave and reserve releases.

“Our pricing model shows that the $8/bbl price decline since late October is equivalent to the market pricing in 4 mb/d combined hit to demand or increase in supply over the next three months,” the bank’s Damien Courvalin said, adding that,

This would be equivalent to a 100 mb government stock release as well as a 1.75 mb/d hit to demand due to the current COVID resurgence. To put in context, this would be double the size of the strategic stock release considered according to Reuters (which, if implemented in swaps, would be even smaller), as well as a global COVID impact that would be c.1.5 times that of last winter, when vaccination rates were extremely low (and with the current stock of DM hospitalizations at a third of its level this time last year).

For something (oil) that’s ostensibly driven by relatively straightforward supply/demand dynamics, forecasting crude prices isn’t usually very straightforward. Even if you master the fundamental drivers and understand the impact of hedging, speculation and the potential for certain investor types (i.e., CTAs) to exaggerate directional moves, you also have to take account of geopolitics.

In any event, JPMorgan’s Marko Kolanovic (who’s weighed in several times this year on the world’s burgeoning energy crisis), suggested Monday that oil actually isn’t expensive at all based on its historical relationship with other assets.

“Oil prices are driven by demand from reopening and growing economies, supply issues due to underinvestment in energy infrastructure and capital flows, increased monetary base and broad inflation,” he wrote. Comparing current oil prices to assets “impacted by similar macro forces” suggests oil may be cheap (figure below).

Specifically, oil sits in just the 12th%ile relative to global equities, the 7th%ile relative to US stocks, the 10th%ile relative to copper, the 20th relative to gold, the 40th relative to bonds, and the 8th relative to central banks’ balance sheets.

If crude prices were to return to the median historical level relative to global stocks, bonds and commodities, “oil would need to be trading at ~$115/bbl,” Kolanovic said.

If oil were trading in line with its historical median relative to the Nasdaq and the size of central bank balance sheets, it would be somewhere between $300 and $500/bbl.