Kolanovic: Oil Is Actually Very Cheap: Here’s Why
Listening to Biden’s press conference this afternoon discussing soaring gas prices and relentless inflation (here Biden pivoted by instead praising the surge in small business creation as if it has anything to do with vibrancy while completely omitting that it was driven by millions hoping to take advantage of the next PPP bailouts when the US enters lockdowns next), which had soundbites such as this:
*BIDEN: GOING TO GET THROUGH THIS GASOLINE PRICE SPIKE
*BIDEN: CHINA MAY DO MORE ON OIL RESERVE RELEASE AS WELL
*BIDEN: UNACCEPTABLE FOR GASOLINE FIRMS TO POCKET GAINS
*BIDEN: WILL DO WHAT’S NEEDED TO REDUCE PRICES AT THE PUMP
… one would think that the US is facing nothing short of a 1970s energy crisis (in where communist China is advising the Biden admin on how to best punish evil US energy companies for daring to “pocket gains” — maybe the US should just nationalize them like every other model communist nation) instead of just a collapse in the polls for Democrats ahead of next year’s midterms.
Sarcasm aside, Biden’s comments do bring up a relevant question: just how expensive is oil… or rather how cheap?
Conveniently, overnight JPM’s Marko Kolanovic answered this question writing that “recently there has been a debate on how cheap or expensive recent oil prices are.” The Croat quant continues that “over the last few days, several countries considered releasing strategic reserves in order to lower oil prices, and OPEC+ is considering how to respond.”
But is that actually required? In his analysis, Kolanovic presents one way to assess the cheapness or richness of oil prices, “namely by looking at the historical ratio to other asset classes.” As he explains, “oil prices are driven by demand from reopening and growing economies, supply issues due to underinvestment in energy infrastructure and capital flows (e.g., ESG), increased monetary base and broad inflation, etc. But how do oil prices now compare to other assets that are impacted by similar macro forces?”
Well, as the chart below shows, by comparing oil prices to other major asset classes over the past 20 years (ratio of oil price to other assets), oil appears very cheap.
As it turns out, oil is only in the 12th percentile relative to global stocks (and 7th percentile relative to US stocks), 10th percentile relative to copper, 20th percentile relative to gold, 40th percentile relative to bonds, and 8th percentile relative to central banks’ asset purchases (balance sheet), etc.
So yes, on a relative basis, oil has very rarely been cheaper!
Kolanovic then calculates that when “focusing only on global stocks, bonds and commodities, oil is in the 19th historical percentile; in order to rise to the median (50th percentile) historical relative level, oil would need to be trading at ~$115/bbl (we say this is conservative because we have excluded “expensive assets” such as central bank balance sheets and Nasdaq, which would imply a median oil price in the $300-$500/bbl range).”
Translation: a $300-$500 oil price is all to realistic in the coming months as Biden’s catastrophic energy policies crash and burn – pardon the pun – and the world is stuck with the dire consequences.
Going back to Kolanovic’s assessment, he summarizes that “relative to broad levels of various asset prices and the monetary base, oil looks remarkably cheap. One could say that oil producing countries (often developing countries) have been subsidizing oil importing countries (often developed countries), given the broad monetary and asset inflation in the developed world over the past 20 years.”
That said, realizing that oil above $100 would promptly result in a global recession, Kolanovic is quick to add the post script that “that this is only one way to look at asset prices and does not represent our near-term price targets.”