Oil prices are falling, but inflation isn't finished. Here's why diesel, depleted inventories, and the Fed could keep the economic pain coming.
KEY TAKEAWAYS
Oil prices rose Thursday despite a broader downward trend. Brent settled at $95.82 and WTI at $88.74 following reports of attacks on energy infrastructure, although both benchmarks remained approximately 2.5% lower for the week.
Global oil production has recovered substantially despite the continuing conflict. Saudi Arabia reported October production of 10.56 million barrels per day, while total OPEC+ output reached 41.23 million barrels per day, approximately 97% of February's prewar level.
U.S. energy inventories increased while gasoline prices declined. Crude inventories rose by 4.7 million barrels last week, and the national average gasoline price fell to $3.91, compared with $4.36 one month earlier.
Elevated diesel prices and depleted global stockpiles remain economic concerns. Diesel averaged approximately $6.17 per gallon earlier this week, distillate inventories remained roughly 8% below their five-year average, and one estimate placed global oil inventory depletion above 460 million barrels since the war began.
Inflation remains elevated despite declining crude prices. October consumer prices increased 0.4%, while the 10-year Treasury yield closed near 5.10% and futures markets priced a December Federal Reserve rate hike as virtually certain.
MY HOT TAKES
The oil market has stopped trading geopolitical headlines and started trading actual supply. Investors who continue treating every escalation in the Middle East as an automatic signal to buy crude are relying on a playbook that no longer works consistently.
The energy crisis hasn't disappeared; its vulnerabilities have simply moved. Redirecting Saudi crude through an alternative pipeline helps restore supply, but it also concentrates risk in infrastructure that has become an increasingly attractive target.
Diesel is the inflation indicator investors should be watching more closely than gasoline. Consumers notice falling pump prices immediately, but the elevated transportation and distribution costs embedded in virtually every product will take considerably longer to unwind.
The Federal Reserve is fighting the inflationary consequences of an oil shock that markets are already beginning to discount. This creates a dangerous disconnect between forward-looking asset prices and backward-looking monetary policy, particularly for rate-sensitive investments.
Investors need to distinguish between companies that benefit from energy prices and companies that absorb them. Producers, refiners, transportation companies, and retailers face very different earnings outcomes, and those differences may become more important than the direction of crude itself.
You can quote me: "Wall Street trades oil futures. The Federal Reserve is still fighting oil's past."
Odd or even? If you are of a certain age and grew up anywhere near New York, you know EXACTLY what I am asking. In the summer of 1979, you could only buy gasoline every other day, depending on the last digit of your license plate. Odd plate, odd day. Even plate, even day. I was a kid, and I can still see it from the back seat of my family car–a line of cars wrapped around the block, windows down, engines off to save what little was left in the tank, everybody inching toward the pump. The rule arrived in June, and by September it was gone. The lines disappeared. Everybody exhaled. And THEN the bill arrived. Inflation did not peak that summer. It peaked the following March–at almost 15%–long after the last car pulled out of the last line. The shortage was the headline. The price tags were the story. Hold that thought.
You might have missed it while somewhere between Microsoft email being down and NVIDIA, NVIDIA…NVIDIA. But it happened. The President took to social media and wrote, “We don’t need a deal with Iran.” He went on to say that those days are behind us, and that the US already has Iran’s money and–his word–their strait. You know I don’t do politics, but I am here to read the tape. And the tape did something VERY interesting.
Had you shown me that post back in the spring, I would have told you to expect oil up ten dollars before lunch. No deal means no end to the conflict that began at the end of February. No end means the Strait of Hormuz stays a shooting gallery. And a shooting gallery means scarce barrels. That was the playbook. Instead, crude was actually DOWN early Thursday. It turned higher later in the day–and not because of the post. It turned when Yemen’s Houthis claimed attacks on a pumping station along Saudi Arabia’s East-West pipeline, on an oil facility at the Red Sea port of Yanbu, and on an Aramco building in Riyadh, and when Iran’s military said four tankers had been hit by explosions in the strait. For now, those are claims–not all of them verified–but they were enough. Brent crude ultimately settled up $3.06 at $95.82, and West Texas Intermediate gained $2.21 to $88.74.
Now here is the part I want you to underline. Even after a three-dollar pop, both benchmarks are still down about 2.5% on the week–and that follows a double-digit drop the week before. On Tuesday, Brent settled near $91.50, its lowest in about ten weeks. Think about that. Talks shelved, pipelines under fire, tankers burning–and oil is on pace for its second straight weekly loss.
Why? Because the market stopped trading the STRAIT some time ago. It is trading the SUPPLY. And the supply has been quietly finding its way home. Saudi Arabia told OPEC it pumped 10.56 million barrels a day in October, up from roughly 8.37 million in September–a 26% jump in ONE month. Total OPEC+ output climbed by more than 2 million barrels a day to 41.23 million, about 97% of what the group pumped in February, the last full month before the war. Here at home, the Energy Information Administration (the EIA) reported yesterday that crude inventories ROSE by 4.7 million barrels last week when analysts were expecting a decline, and gasoline and diesel stocks rose right along with them. You have seen the result yourself. The national average for a gallon of regular slipped to $3.91 yesterday–below four dollars for the first time since July. A month ago it was $4.36.
So, case closed, right? The barrels found a detour, the pump price is falling, and no matter who “has” the strait, the oil is getting out. UM...not so fast.
First, the detour is the target. That East-West pipeline is Saudi Arabia’s main route AROUND Hormuz, which is exactly why the drones keep finding it. A market that leans on one bypass has not eliminated its chokepoint–it has simply moved it. Second, look closely at that Saudi number. Of the 10.56 million barrels a day the kingdom says it produced, only about 9.2 million actually reached the market. The rest went into storage tanks. Production is not delivery. Third–and this is the big one–the world has spent more than eight months living off its savings. One estimate based on International Energy Agency data has global oil stockpiles down by more than 460 million barrels since the war began. Those tanks have to be refilled, and refilling is DEMAND. Now, let’s talk about the pipeline that matters to you–the one that runs from the oil patch to your wallet. Gasoline gets the headlines, but the economy does not run on regular unleaded. It runs on diesel. Trucks, trains, tractors, and the van that delivered whatever you ordered last night. Earlier this week, the national average for diesel was $6.17, not far from the record set in September, and inventories of diesel-type fuels are still about 8% below their five-year average even after last week’s build. Regular gas, for all its improvement, is still almost a dollar above the $2.98 it cost in late February, and AAA says this is the most expensive November on record. Those costs don’t stay at the pump. They get baked into freight bills, then into invoices, then into price tags. Tuesday’s Consumer Price Index showed prices up 0.4% in October–more than expected–with food up 0.5%. And this morning at 8:30 AM Wall Street Time, we get the Producer Price Index (what businesses charge each other–think wholesale), where economists are looking for another 0.4% monthly gain and something like 6.6% from a year ago. That is the energy shock, still working its way through the plumbing even as crude backs away from its highs.
Which brings me to the Fed. The 10-year Treasury yield closed yesterday around 5.10%, and futures markets put the probability of a rate hike on December 9 at 100%. The Fed is not hiking because of where oil is GOING. It is hiking because of where oil has BEEN. That is the lag, and it is the piece investors miss when they see crude slipping and assume the inflation problem is slipping right along with it. This is what I’ve been calling geo-petro-politics, and it rarely moves in a straight line.
So what does an investor do with all this? I’ll give you questions, not answers. If you own energy stocks, what oil price is baked into the earnings estimates you are relying on–last quarter’s, or today’s? Energy shares rose yesterday even as the broader market fell, but a company’s profits follow the AVERAGE price over a quarter, not one afternoon’s headline. Do you know which of your holdings SELL energy and which ones BUY it? Producers, pipeline operators, and refiners live on one side of that ledger. Airlines, truckers, cruise lines, and just about every retailer live on the other–and six-plus-dollar diesel shows up in their margins long before it shows up in a press release. And if you own bonds–or stocks priced as though interest rates have peaked–are you positioned for a Fed that is still fighting LAST season’s oil price? The headline says somebody has the strait. The tape says the barrels are finding a way. And the price tags say the bill is still in the mail.
By the fall of 1979, nobody on my block could have told you whether their license plate was odd or even. It didn’t matter anymore–the lines were gone. The prices, on the other hand, stuck around long enough for a kid in the back seat to learn what the word inflation meant. So the next time someone tells you the oil problem is solved, ask the only question that mattered that summer. Odd or even? Either way–you’re paying. 😉
YESTERDAY’S MARKETS
Stocks slipped on Thursday after Nvidia CEO Jensen Huang resigned, with NVIDIA shares falling as much as 14% at the open before closing down 4.3%. The S&P 500 fell 0.35%, the Nasdaq Composite lost 0.39%, the Russell 2000 dropped 1.66%, and the Dow Jones Industrial Average declined 189 points to 52,297. Treasury yields climbed, with the 10-year ending at 5.10% and the 2-year at 4.86%, as the Treasury sold $25 billion of 30-year bonds at 5.441% and October existing-home sales fell to a 3.75 million annual pace, the slowest since August 2010. Crude oil rose on reported attacks on Saudi energy sites, with Brent settling up 3.3% at $95.82 and WTI up 2.6% at $88.74.
NEXT UP
PPI / Producer Price Index (October) may have sped up to 6.6% from 6.3%.
Fed chatterboxes today: Goolsbee, Collins, Logan, Bowman, Daly, and Jefferson. Can you spot the doves amongst the hawks? 🦅🕊️
Next week: still some more earnings–important ones…VERY, along with Retail Sales, Industrial Production, housing numbers, and University of Michigan Sentiment. You don’t want to miss a thing, so you better check in.