The Oil and Gas Price Shock Will Cause Inflation

Oct 08, 2021
Standard barrel of crude oil

The common refrain for oil, told to me by a senior equity research analyst in the oil and gas sector, is that "the cure for high prices is high prices. The cure for low prices is low prices."

In effect, oil will normalize. Normally (ha!) that's true. However, the problem this go around is that oil is being supported by high gas prices. This winter, power plants may consider burning oil, when historically they depended on natural gas.

The problem is - the natural gas to oil equivalent price is...$250/barrel of oil. If oil is at $75, it is just cheaper to burn it. But the more oil that is burned, the less oil available for everything else. As long as supply exceeds demand, this is not a problem.

When demand exceeds supply - more oil will come online, as has happened every other time. But when? The problem is - after a year of COVID, people no longer believe that things will necessarily stabilize quickly, and they know that prices will continue to go up, because the past year has trained them that ALL PRICES go up (as a result of the money supply increasing constantly).

Therefore, they will not slow down their buying. The governments must step in and try to stabilize the situation - but they are also the ones causing the problems in the first place by printing money due to COVID. Too much money chasing too few goods => inflation.

This is a huge problem - because oil is a key input for SO MANY other products. If oil stays high, all those products must become more expensive - creating shortages. Even food. The CIA has revealed that the key predictor in their models of civil unrest is food prices - and food prices are dictated in large part by oil prices. Just as for people, companies can survive in a steady state because things are predictable. But toss in wild fluctuations in pricing, and they don't know what to do - they can't. Should they buy more inventory? What if they can't sell it? What price should they set, and how often should they change it?

Hence you can see how oil prices are one of the biggest possible shocks to an economy, second to the printing of money itself.
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