Markets ≠ The Economy: Oil
Crude oil is another commodity that market participants like to look at in order to gauge the overall health of the global economy. The logic here is the same as with copper, since oil is what the modern industrialized economy runs on, a higher price per barrel must mean strong global growth… right?
Alas, as mentioned before, and will most probably have to be mentioned over and over again, it never is so simple.
Again, like copper in Covid 2020, do not forget what producers are (or aren’t) doing. For oil this is doubly important because of the outsized influence Saudi Arabia (OPEC), Russia, and American shale producers have on the market.
The confluence of every negative factor possible caused chaos in the ranks of American shale producers, leading to many filing for bankruptcy protection. The aggregate debt of these producers was approximately $50 billion, close to 2016’s record of ~$57 billion, and 2016 was a horrible year, where WTI bottomed out at ~$30 a barrel after selling off from highs of ~$100+ a barrel in 2014.
Needless to say, supply in the American shale patch was very badly affected, with oil and gas extraction dropping sharply, while drilling of new wells fell below 2016’s low. Note that both index values have not recovered to their pre-pandemic levels.
Obviously, everyone else was suffering as well, and Saudi Arabia with its OPEC allies came together with Russia to jointly cut their production in order to force prices higher.
As with copper, these supply cuts and bankruptcies coincided with global reopenings and the massive rebound in demand that comes with industries bringing back production capacity, with exactly the same result – an upward surge in prices.
It cannot be overemphasized how important it is to gain an understanding of both supply and demand before coming to some kind of conclusion about what commodity prices represent. Jumping to the conclusion that higher commodity prices, especially energy, are due to a robustly growing economy is a very linear and reductive way of thinking about a very complex global system.
Avoid reductive thinking as much as you can.
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