In a recent article, Lyn Alden gave her perspective on why when it comes to energy, how long prices stay high is more important than how high prices go. Using EOG’s Free Cash Flow over the last two decades, she highlighted how the energy industry, as of recently, is acting more rationally.
In the first decade, the company experienced negative cash flow because it spent aggressively on new production that was not particularly profitable. Although investors were happy to provide financing during this period it caused a lot of capital destruction.
In the following decade, companies like EOG did not have to hike energy prices yet they could easily generate free cash flow, maintain a strong balance sheet, and return profits to shareholders.
High Oil Prices Aren’t Bad, What Matters Is How Long They Stay High
Prices of crude oil, natural gas and gasoline could double for a couple of weeks and quickly go back down and the general public would be fine. People would complain temporarily about the high prices but that would be it.
But imagine if prices went up by say 50%-100% and stayed there for the next several years, imagine the devastation the global economy would experience. The pressure it would have on the average household budget and business operations would be massive. Most individuals and families would eventually have to reprioritize, cut back on discretionary spending or even fall below the poverty line.
This shows that the duration of high energy prices has a bigger impact than how high the price gets when it comes to how it impacts the everyday lives of consumers.
America’s Oil Consumption
Currently, WTI crude oil is over $100 per barrel, despite the effort of the US Strategic Petroleum Reserve to suppress oil prices. Oil could drop to $60 in a severe recession but this seems more like an isolated outcome rather than the base case.
Lyn Alden prefers not to predict specific price drops or hikes but instead has the view that the base level around which oil fluctuates will be higher over the next five years and the five years after that than it was in the previous five years. This would have very severe implications for individuals and consumers, since energy is an essential expense.
Every once in a while, as a result of a combination of persistent currency debasement and cyclical commodity cycles, the market experiences a “new normal” in the price of oil.
Nothing New Under the Sun
The economy goes through the same or similar cycles every couple of years. This is also the case when it comes to oil and commodities in general. After a steady period between 1950 and 1960, with the US going off the gold standard, oil production reached a structural peak causing an increase in the price level. It occurred again in the 2000s due to a decade of currency debasement and a new period of undersupply kicked in after a steady period between the 1980s and 1990s.
After another steady period in the 2010s, with prices dipping briefly during the pandemic in 2020, which triggered the biggest ever percentage global reduction in oil usage. Apart from this, there has been a permanent increase in the price range of oil.
All indications point to a new round of price discovery for the price of oil, during which oil prices will adjust to the persistent higher price level and become the “new normal”
Discovering the “New Normal”
Numerous cyclical factors affect oil prices any given year, but the increase in currency supply and major oil production and transport cycles dictate where the new “normal” price for energy will be in the next decade.
Over a multi-year period, the world enjoyed high energy abundance. A lot of analysts believe we’ll return to this abundance, but Lyn Alden has doubts that this current period is anything but normal.
Energy is an integral part of businesses and the everyday life of individuals. If prices stay high, eventually permanent changes would have to be made to how these businesses operate and how individuals live.
The effect of oil price increases on inflation in the 2000s was offset by aggressive offshoring of manufacturing to China. While this was effective then, this move can certainly not be replicated in the 2020s.
