The Main Reason Oil Prices Won't Go Above $80 Per Barrel

As highlighted repeatedly by OilPrice.com there are two extremely powerful reasons why the oil price has been effectively capped around US$75-80 per barrel of Brent since the end of the 2014-2016 Oil Price War.

These two reasons remain in place and are the key factors why no matter how much various investment banks and funds have talked their (long) books with tales of how and why the oil price should be at US$80 or US$90 or US$100 or above per barrel it has not got there.

There has also been talk recently that the new U.S. President, Joe Biden, would be happy to see oil prices go much higher, given his supposedly 'green agenda' - as this would narrow the effective price gap between expensive green energy offering and hydrocarbons ones - but as also highlighted by OilPrice.com, it is funny how often and how quickly such lofty principles disappear in the cold light of hard political self-interest. Indeed, Biden’s comments last week highlight that he is not willing to tolerate a break of the effective oil price cap and that both key reasons for the cap to remain in place are still in play.  The first reason is that the higher the gasoline price (and this is in significant part a function of the price of crude oil) the less the domestic consumer spending-driven portion of the U.S. economy will grow. Specifically, the unequivocal formula is this: for every cent that the U.S.’s average price of gasoline rises, more than US$1 billion per year in discretionary additional consumer spending is lost. As an historical rule of thumb, every US$10 per barrel change in the price of crude oil results in a US$0.25 change in the price of a gallon of gasoline. The ‘danger zone’ for U.S. presidents starts at around US$3.00 per gallon and at US$4.00 per gallon they are being advised to pack their bags in Pennsylvania Avenue or start a war to divert the public’s attention. The point was underlined by Bob McNally, the former energy adviser to the former President George W. Bush that: “Few things terrify an American president more than a spike in fuel [gasoline] prices.” 

This is precisely the first reason cited last week for the warning from President Biden’s administration to OPEC+ producers that they must increase their crude output in order to lower oil prices. Biden’s National Security Advisor, Jake Sullivan, could not have stated it more clearly as he said: “Higher gasoline costs, if left unchecked, risk harming the ongoing global recovery.” He added: “While OPEC+ recently agreed to production increases, these increases will not fully offset previous production cuts that OPEC+ imposed during the pandemic until well into 2022…[and] at a critical moment in the global recovery, this is simply not enough.” 

The tone of the warning to OPEC+ from the Biden administration is remarkably similar to the one employed in former U.S. President Donald Trump’s same warnings to OPEC and OPEC+ members on the only other occasion in the past five or six years when the Brent crude price rose significantly above the US$70 per barrel level for any sustained period and looked like threatening the price cap. This was in the second half of 2018, with the Saudis ramped up prices in concert with Russia. The message sent at that time by Trump made clear that in the U.S.’ view Saudi Arabia was contravening the foundation 1945 agreement on Bitter Lake between Roosevelt and Abdulaziz and, therefore, putting at risk the U.S. support of the Al-Saud ruling family as the monarchy of Saudi Arabia. “OPEC and OPEC nations are, as usual, ripping off the rest of the world, and I don’t like it. Nobody should like it,” he said. “We defend many of these nations for nothing, and then they take advantage of us by giving us high oil prices. Not good. We want them to stop raising prices. We want them to start lowering prices and they must contribute substantially to military protection from now on.” 

Related: Oil Sinks As Demand Outlook Worsens

The only surprise for those of us who have been trading oil profitably for years based on the near certainty of this price cap is that the gasoline price catalyst for the cap’s reiteration has now come at a slightly lower crude oil price than usual. Based on recent historical precedent, a US$90-95 per barrel of Brent oil price equated to around US$3 per gallon of gasoline and a US$125-130 per barrel of Brent equated to around US$4 per gallon of gasoline. However, this time around, U.S. retail gasoline prices averaged US$3.14 per gallon in July (the highest monthly average since October 2014) whilst Brent crude struggled in that month to trade about US$77 per barrel, mostly averaging US$75 per barrel and less. This was despite the ongoing efforts of Goldman Sachs at that point and in the months preceding it to talk it up to US$80 per barrel, with all of the associated guided buying that goes with this sort of implied price target. After July, Brent fell back again and has traded nowhere near even US$75 per barrel on a sustained basis. 

The second of the two reasons that have kept the crude oil price cap in place since the end of the 2014-2016 Oil Price War is political and is a corollary of the generally deleterious economic effect on the U.S. economy of increasing oil (and, therefore, gasoline) prices. Specifically in this regard, according to U.S. NBER statistics, since World War I, the sitting U.S. president won re-election 11 times out of 11 when the U.S. economy was not in recession within two years ahead of an election. However, presidents who went into a re-election campaign with the economy in recession won only once out of seven times (Calvin Coolidge in 1924, although strictly speaking he had not won the previous election but had rather taken up the position on the death in office of Warren G Harding). President Biden is not facing another presidential election for four years, of course, but he does face critical mid-term elections within the next two years - November 2022 - when his Democrats could lose their narrow majority in the House of Representatives. As of the last election, the Democrats held 222 seats, with 218 needed for control, whilst it was 50 seats each for the Democrats and Republicans in the Senate, with the Democrat vice-president constitutionally holding the tie-breaker vote. 

By Simon Watkins for Oilprice.com

More Top Reads From Oilprice.com:

• U.S. Rig Count Rises To 16-Month High
  
• Where Does Wall Street Think Oil Is Heading?
  
• U.S. Natural Gas Dominance May Be Coming To An End