Central Banks and Higher Energy Prices

Higher energy prices continue to dominate news coverage.  Republicans are blaming Democrats for unfriendly domestic and offshore drilling regulations. Democrats are blaming Republicans for failure to support alternative energy funding. Missing in most of the conversation is the fact that central banks throughout the world are pumping trillions of dollars into markets in an effort to prevent deflationary pressures from taking hold.

There are lots of reasons for oil prices to be going up, of course. Demand is rising in the emerging markets, where growth is still strong. There has been a cold snap across Europe, increasing demand for heating oil. There is tension with Iran, and a revolt in Syria that may soon turn into a civil war. Russia has a tense presidential election this weekend: turmoil there might hit what is now the world’s largest producer of oil, if not yet the largest exporter.

But the main reason is one that is rarely mentioned. The world is being flooded with printed money. In reality, oil is not expensive. It is money that is cheap.

Central banks are fast getting locked into a destructive cycle. They print money to try and pump up demand. Commodity prices rise, which then takes demand out of the economy again.

Worse, it constantly distorts the global economy, draining money from manufacturing nations like Italy or France, and pumping it into resource-rich countries like Russia or Saudi Arabia. Since the manufacturing countries are usually more productive, and more democratic, that hardly makes much sense.

Crude oil futures generally will be on the bid whenever daily excess supply slips below 5,000,000 barrels per day. We are currently at an estimated excess supply of 2,500,000 barrels per day. Reports that Iran oil production is falling helped to drive NYMEX reformulated gas futures up .05 in 5 minutes on Friday.

When fear of tighter supplies meets continued central bank money printing, traders will be reluctant to short energy futures. However, should central bankers turn off the money spigot, fear of the market going down will return and WTI crude futures should be able to find a comfortable home under the three figure handle.