Last week today – Vladimir Putin inaugurated for his second consecutive (and fourth overall) Presidency of Russia; Kim Jong Un summoned to China for second time in two months (no doubt related to the upcoming summit between Trump and Kim); Trump withdrew from the Iran nuclear deal (despite pressure from France, Germany, and Britain); North Korea released three U.S .hostages (again, no doubt related to the upcoming summit between Trump and Kim); Trump announced date (June 12) of meeting with Kim Jong Un; Producer Price Index (PPI) and Consumer Price Index (CPI) measures of inflation for April were below expectations.
Global equities rallied more than 2% for the week, with U.S. equities leading the way (S&P 500 + 2.5%) on the back of strong earnings reports. In Q1, Earnings per Share for the S&P 500 increased by 23%, the fastest rate since Q2 2011. Its worth noting that roughly 20-percentage points of the year-over-year growth are related to a combination of stock buybacks and tax cuts, leaving only a handful of percentage points from organic (i.e., non-financially engineered) earnings growth. Yields on U.S. Treasury bonds maturing in 2-10 years rose a few basis points, while 30-year bond yields declined modestly. The yield curve flattening trend remains firmly intact as investors handicap the odds of the Fed continuing to tighten in the absence of strong inflation pressure. Commodity prices were generally higher as precious metals (Gold +0.4%, Silver +0.8%) recorded gains, and the price of a barrel of WTI Crude increased by 1.4% to $70.70 per barrel.
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Crude Facts I – Having surpassed Saudi Arabia last year, the U.S. is now neck-and-neck with Russia as the world’s top oil producer. Granted, Saudi Arabia and Russia committed to cap production in early 2017, as both countries wished to remove excess supply from the market to boost the price of crude. Saudi Arabia led the production cut initiative seeking to increase the value of the planned IPO of state-owned Saudi Aramco – the world’s largest oil company. Saudi Arabia is a country undergoing significant change. In addition to loosening its rigid social conservatism (women are now allowed to drive), the royal family sees the future and is desperate to diversify the Saudi economy away from a reliance on hydrocarbons.
Source: The Wall Street Journal
Russia is desperate as well, but not for change. Instead, Russia’s President Vladimir Putin is known to look backward, seeking to re-establish Russia to the vaunted world power status once commanded by the U.S.S.R. Vlad’s playbook is defined by possessing a strong military and a foreign policy known as “realism.” That is, Russia believes foreign policy is a zero-sum game in which one state can only make gains if others lose. The problem for Vlad is that his approach has brought international condemnation (conflicts in Syria and Ukraine, and meddling in the 2016 U.S. presidential election) and crippling sanctions that threaten his military spending. Vlad sees higher oil prices as an elegant solution to offset the negative impact of current sanctions and any new sanctions that may be forthcoming as he pursues his vision of a great Russia.
So you have two oil-rich countries, willing to cap crude production, to secure very different versions of the future. In the meantime, for U.S. oil companies, higher crude prices mean its time to “pump, baby, pump.”
Crude Facts II – No single state in the union has benefited more than Texas from Saudi Arabia/Russia production caps. Saudi Arabia famously tried to crush the U.S. fracking industry by refraining from production cuts in the face of declining oil prices and the price of WTI crude eventually hit $26.21 in February 2016. Low oil prices caused real pain in the U.S. oil industry, but U.S. energy producers were more resilient than the Saudi’s had bargained for. Not only did the industry survive, but producers became more efficient, and reduced breakeven extraction prices by an average of 25% in key Texas oil fields (2015 breakeven prices shown in red; 2016 breakeven prices in blue).
Source: Eagle Global Advisors
Rising oil prices combined with lower extraction costs helped drive the Texas state economy to a 5.2% annualized growth rate in Q4 2017, twice the pace of the broader nation’s 2.6% GDP growth rate. Fast growth requires labor, and Texas added more manufacturing jobs (oil field jobs are considered a “manufacturing” job by the Bureau of Labor Statistics) than any state in 2017.
Indeed, Texas is not the only state benefitting from higher oil prices. Extraction activity (and associated job creation) is increasing in Pennsylvania, North Dakota, and New Mexico as operations become profitable at current price levels.
The Bottom Line – Once considered enemies of the fracking industry, Saudi Arabia and Russia’s independent motivations for higher oil prices are a boon for U.S. energy interests.