Today we are going to shift gears away from tariffs and big, beautiful bills thankfully. We are going to examine where the puck might be going soon. I don’t think this is an immediate threat, but there are storm clouds brewing. There are plenty of people talking about how inflation is coming down and that sure enough tariffs don’t cause inflation. Well, they cause higher prices which is a measurement of inflation, but that is only on items purchased from abroad. It also takes more money out of the shopping basket of anyone on a fixed income because they can’t afford some items while they are paying more for items that are imported. This slows growth, which can lead other companies to make less sales and then they discount their prices which eventually leads to lower prices as they need to make sales. Tariffs are just a tax that shifts the money from consumer and business pockets to the government’s pockets. In the short term they lead to higher prices on some items and lower prices on others, but they aren’t the driver of disinflation that we are experiencing right now. That would be due to energy prices.
Since the June 2022 high at 9.1% CPI, which is a terrible way to measure inflation but the typical government statistic these days, inflation has been trending down. We still aren’t at 2% though, but just above at 2.4%. That’s 20% above target for those of you that spend money at home. Why was inflation so high then? Some will blame the Fed, some will blame Joe Biden, and some will blame Donald Trump. All contributed to the massive stimulus given to the American people like they were at a quinceanera. Something else notable happened in June 2022, that is when energy prices peaked. Russia had invaded Ukraine that spring, and suddenly energy prices which go into everything were skyrocketing. Then inflation was peaking, coincidence, of course not. Now energy prices like Brent crude are in the low to mid $60 a barrel range and we see inflation coming down. Here is the rub. Gas prices have dropped from $4.93 in June 2022 back to $3.15 today which is the same price as Aug 2021. That’s a long way from the $2.44 in February 2020 right before Covid.
Now what has changed is the composition of the crude oil landscape. American crude oil production is now the highest in recorded history. That is right, the highest in history, more than Iraq and more than Saudi Arabia. We are producing 13.5 million barrels per day. Now we have talked about how we still import crude oil for our own needs due to the light sweet crude we mostly produce and the heavier more sulfuric crude that our country is set up to refine. This is a leftover of the dependence on Middle East crude and a lack of building new refineries in 40 years. During the Great financial crisis the US was producing about 5 million barrels per day, but low interest rates saw many a wildcatter head to the fields as oil prices were high and well over $100 a barrel.
Recently OPEC has decided to start increasing production. It happened right during the tariff announcements and the oil price promptly sold off with the glut of crude oil about to hit the world market. The price is lower, and OPEC wants to make their money on volume and not necessarily the price. They have a lower per barrel extraction cost than the United States. Russia is at $17 a barrel according to Statista while Saudi Arabia clocks in at $9.90. Iran at $12.60 and even Venezuela at $23.60 are all significantly lower than the US rate of $36.20.
American production has exploded in recent years with the onset of fracking. This is a newly adopted technique to extract energy from shale rock. Fracking has led America from 5 million barrels just 15 years ago to 13 million barrels a day, today. We are energy dependent on other countries because we need their type of crude oil, but since we export so much oil we are energy sufficient. This has interrupted the world order. We used to buy oil and ship dollars out into the world and they would buy treasuries especially the Middle East. Now they are trading in Yuan because China is the biggest buyer. Now why is this so important?
Low energy prices here at home have helped keep inflation low. Fracking unlocks lots and lots of natural gas that is literally burned off in many areas, but the industry’s technology has managed to capture more and more of this seemingly free energy. We are now shipping more natural gas than ever and building liquefied natural gas terminals where ethe gas which is transported as a gas gets the temperature lowered to be transported as a more stable liquid. This has been profitable and a wonderful use of the fracking technology.
Unfortunately, fracking is staring into an abyss. This from ZeroHedge, “Two weeks after Travis Stice, CEO of shale giant Diamondback Energy, warned that the US energy industry “is at a tipping point” and – more ominously – that US shale output has finally peaked (resulting in Diamondback slashing its capex budget as Saudi Arabia launched the latest OPEC+ price war), we now have confirmation that the CEO was right.
As Goldman commodity strategist Yulia Grigsby writes in her latest Oil Tracker note, amid continued declines in oil prices, there was a silver lining: namely that US total rig and frac spread count continued to decline quickly, especially in the Permian, -14% and -22% from year ago…And, having previously taken stock of Q1 earnings reports, we remind readers that several high profile public producers already reduced their drilling and completion activity on the back of lower prices and most producers reduced their 2025 capex guidance. As a result, Goldman expects the crude production in the US Lower 48 to decline by 0.4mb/d by 2026Q4 from 2024Q4.
Incidentally the latest Baker Hughes data showed that rotary rigs in the US tumbled by another 8 in the latest week… …and are now down to a 4 year low of 465 as the industry enters crisis “cash conservation” mode.”
When rig counts drop that means the producers do not see it as profitable to continue drilling. This is what always happens when people drill baby drill. The market gets saturated with supply and prices fall and people stop producing and soon there will be a shortage and the prices will rise. This is just a business cycle. The fracking industry is saying with their actions this isn’t profitable for us and so these levels are where the production curve should start to descend. Back to ZeroHedge, “But one doesn’t have to believe in “peak oil” to expect further US production declines: regulation and sharply higher extraction prices may suffice to send the price of oil surging.
According to Bloomberg, Texas regulators are warning that wastewater from fracking in the biggest US oil basin is causing a “widespread” increase in underground pressure — a development that risks hindering crude output and harming the environment.
Shale oil wells in the Permian Basin generate millions of gallons of chemical-laced water, which drillers then pump back into the earth. Landowners and activists have said for years that this process causes toxic leaks. Now the state’s powerful oil and gas regulator, the Railroad Commission of Texas, is acknowledging the scale of the problem and imposing restrictions that could increase crude production costs. Producers began injecting more water into shallow rock formations roughly five years ago after pumping it deep below the surface was found to trigger earthquakes. But the volumes are now so large that the dirty water is breaching wells and causing the ground to swell and rupture, threatening to contaminate drinking supplies for people and livestock.”
This is such a new technology at scale that frankly we don’t know what is happening. There have been earthquakes, hundreds, reported in places that didn’t have seismic activity. Now there are concerns about injecting the toxic water back into the earth at volumes this big. If the drinking water gets affected for humans or livestock, the exodus from these areas will be immense. Trump has isolated many countries like Venezuela or Colombia which could be an alternate source of supply. Even Canada doesn’t want to sell us their oil although they will as we are mutually tied at the hip with regards to energy right now. That’s why the halt in production would have enormous ramifications as well.
More from ZeroHedge, “Permian Basin oil production has soared over the past decade to about 6.7 million barrels of oil each day, more than the output from Iraq and Kuwait combined, and in some views has become a global swing producer. But for each barrel of crude, it produces three to five barrels of water that contain so much salt and toxic materials that pumping it back underground is the only cost-effective disposal method…The shallow disposal zones, located between oil-rich layers of shale and the surface, consist of porous rock that can absorb water. But the 100-year history of crude production in the Permian means they are perforated with thousands of well bores, some up to a mile deep. Because of higher water pressure, fluids are now breaking through to oil drilling areas and old wells that were either abandoned or poorly cemented shut decades ago.
The regulator’s tighter restrictions come just weeks after Coterra was forced to halt some oil production in Culberson County, Texas, after waste fluids leaked into its wells…One person who’s not surprised is Sarah Stogner, the district attorney for three West Texas counties in the Permian Basin. She’s been warning of rising subsurface pressure since 2021, when a landowner noticed oil and gas oozing from old wells on her property that had sat idle for decades. Stogner, then a lawyer for the landowner, publicized the case on social media, calling them “zombie wells.” Over the next few years, several more wells blew out in the area, with some ejecting toxic fluids more than 100 feet in the air for several days…One blowout near Imperial, Texas, gushed toxic water high in the air for two weeks and had to be cemented shut in 2022. Researchers at Southern Methodist University later found the ground around the eruption site had been steadily bulging for three years, eventually rising 40 centimeters (16 inches) before it burst open…
To Stogner, the measures are an admission that toxic water leaks are a serious problem for the regulator, and for the Permian Basin. “They just completely ignored us,” she said. “But now they cannot deny that it’s happening.”
And with that, oil producers will no longer be able to sweep the toxic problem under the rug – or ground as it may be – and since the mandated changes will require millions if not billions in additional spending to comply with regulations, which means all-in production costs are set to soar, and since oil prices will only continue to slide, we are about to see a wholesale shutdown of the Permian, and – as because the commodity cycle never fail – all the excess production in the US will turn into a deficit, sending oil prices soaring as the commodity bullwhip effect comes home.”
Wow! Fracking has provided a patch for our energy problem. It seems that the composition of the oil production is about to change. If the Middle East and OPEC drives oil prices lower and frackers are forced to close up shop, the Middle East will gain market share versus the west. If regulations due to water safety increase the costs of restarting fracking operations even when prices inevitably rise, then OPEC wins even more as they get more market share, they get higher prices to meet their own capital expansion goals, and the US gets inflation since inherent in the price of everything is the price of oil.
Scott Bessent has largely been a godsend with Trump being the poster boy of what not to do with poster boards. He has calmed the markets, the markets respond when he has spoken, and he seemingly has Trump’s ear, for now. Bessent had a well-publicized plan of 3/3/3 to reduce budget deficits. He was going to cut the budget deficit to 3% from its current level of almost 7%. He was going to boost GDP growth by cutting regulations and other pro-growth policies up to 3%, and he was going to increase oil production by 3 million barrels a day. This would lower energy prices and thus stimulate the economy.
That sounds like a good plan. However, Doge has struck out and the big beautiful bill is going to keep budget deficits at least where they are as a percentage of GDP and maybe even push it higher. The very same bill is going to have a very tough time making it out of the Senate in a form that the House will approve. Senators like Rand Paul and Ron Johnson are revealing themselves to be true fiscal patriots and not allowing a pork laden bill that will expand the debt pass. I expect something to pass because if not there will be a huge tax hike as the 2017 Trump cuts will expire. However, I don’t think the bill will provide anywhere near the 3% growth projections that Bessent was anticipating.
Now we have energy production not expanding 3 million barrels but possibly dropping? This is exactly where I anticipate us going. Higher interest rates will lead to less companies being able to borrow the money to commence drilling operations, as we are in the opposite of what happened 15 years ago. If the fracking boom is over due to water concerns, the US retreat from energy security to energy dependence will be an expensive one. Inflation will increase again, and right when gas prices are higher, and interest rates are higher, and soon Bessent’s 3/3/3 bill will be completely unachievable in any one of its goals, much less all three.
Toxic Texas could become the match that leads to the second major round of inflation in this country. The reversal of energy prices could signal the reversal of inflation because it hasn’t been reversed by responsible government spending, quite the contrary. Even if the government allows more leases for traditional drilling, which I anticipate it will, there is one more part of the situation that I find interesting.
During the decade of 2000-2010, for most of that time the price of natural gas was over $5 per million btus. Only during the Russian invasion into Ukraine and the European fallout of losing their cheap energy source, has the price of natural gas risen above $5 in the last decade. That is due to natural gas being such a plentiful byproduct of fracking that its enormous supply has caused it to become extremely cheap. What happens if fracking just starts to go away. Not entirely, but just gets materially less common. The price of natural gas will go up. Do you know how many things have been depending on natural gas and in particular cheap natural gas as the backup for the failed solar and wind power endeavors? We can’t afford expensive natural gas any more than we can afford higher crude oil or higher gas prices at the pump. AI data centers are relying on natural gas to be the key underlying source of energy to produce the electricity they need. It looks like their plans could end up going the way of Scott Bessent’s.
There has been such an underinvestment in critical commodity resources for the last 25 years that our society is bumping up against a ceiling of what we can realize without massively higher prices and shortages. We have discussed the copper shortage for electricity needs alone for these new plans of EV cars, solar panels, and data centers. The copper isn’t there. The world has run a silver shortage for years now, yet silver is needed for these very same projects. Now we are staring down a potential energy crisis looming just over the horizon. I don’t think this will happen next month mind you, but I do see it starting and it will accelerate. All these headwinds seem to be gathering against us. It is a simple case of borrowing from tomorrow. We have put off to do tomorrow what should have been done today. No one wants to take resources and put them toward opening a smelly copper mine, but everyone wants the electricity it provides. No one wants to smell the crude oil refinery, but people sure like driving cars. If you think the projections on manufacturing an iPhone in the United States is high at $3,500 currently, wait until the price of energy triples. The price of oil has dropped 36% from its June 2022 highs, have your insurance rates? How about your grocery bill? How about the price of a new car?
In closing, I have one more thing to say. There is a stat that I watch called the gold to oil ratio. Gold has been in the news for making new all-time highs and we have just discussed how cheap oil is getting. Well, that spread peaked in July 1973, Mar of 1986, and Jan of 2016 in the low 30s. That means one ounce of gold would buy 30 barrels of oil. The all-time high was set briefly during covid when technically the price of oil went negative. However, with that exception the current ratio is at 53. All time highs…Gold is priced in dollars, and we are printing them at an accelerating speed so I doubt gold can go down significantly although a retreat from all-time highs could be warranted. Therefore, logic would suggest that the price of oil is due to go higher. The nuance is that if OPEC picks up the market share the price doesn’t have to go that much higher globally, it would simply go higher here. That would affect us, all of us. We need to keep an eye on toxic Texas for the signal.
Sincerely Yours,
C Thomas Printer
Also born on this date… King George III of Great Britain. The man that lost the Revolutionary War, to us.
Thank you for listening today and you can find all of our articles and more on our website cthomasprinter.com.