Ive here. This “thought-provoking view” of the price outlook still avoids its focus on a seriously bad tail risk level outcome. A sharp rise in fuel and food prices will lead to a revolt, as we saw in the Arab Spring. America is too fragmented and Americans have been indoctrinated to look down on protest, so I’ve long seen more and more violence and theft more likely than organized insurgency. But European countries are dominated by one or two big cities and have more remnants of their unions, so general strikes and other mass protests could be on the horizon. ‘

By Lynn Parramore, Senior Research Analyst, Institute for New Economic Thinking.Originally Posted in New Economic Thinking Institute website

Hyperinflation not seen in four years, the pain of fuel prices spreading across the rest of the economy, the incursion into Ukraine’s energy market and long-term climate goals hampered by the need to stem the price spiral. That’s enough to make you dizzy. Industry researcher Muayyad Al-Chalabi shares with the Institute for New Economic Thinking his views on fuel issues and energy challenges that everyone is worried about.

Lynn Parramore: Let’s start with the general picture of the fuel market. We’ve had some ups and downs during the pandemic, but nothing too worrisome. Now, all of a sudden, everyone around the world is facing rising oil and gas costs. How is this going? How much is about the Russian invasion of Ukraine?

Muayyad Al-Chalabi: Some of them go back before Russia. With all the public policies and agreements we’ve seen, the idea is to switch to renewable energy and reduce emissions. As a result, investment in oil infrastructure has been declining. In terms of production of things like gas and oil, there have been no disruptions – the US still produces 11.5 billion barrels of oil per day. However, investment in new oil exploration, new leases, etc., as well as capital expenditures, has fallen, both in the U.S. and elsewhere. What you’ve got is the market saying, well, there’s no investment in this new infrastructure, and demand is growing, so investors are predicting the gap, at least from a futures perspective, and seeing that renewables may not be able to fill it. The first phase of rising costs really started with a change of government and Biden’s focus on green energy. Even before we know what’s going on in Ukraine, prices have gone up.

Now, with the Ukraine conflict, we have entered the second phase of price increases, which has the potential to take 10 million barrels of oil from the market – that’s almost 10% of the entire market. We went from $100 to $115, $120 a barrel, but then dropped a little bit. We’re also now seeing demand bounce back from the pandemic, but not as much as many think. It’s true that there is more demand for oil than in 2020, but not much different from 2019 – actually around 5% less.

LP: All of this puts the Biden administration in a bind. First, they’re talking about a green future, and now it’s rigs, baby, rigs, because fuel has become so expensive.

MA: A lot of environmentalists want the price of fossil fuels to go up because then the difference won’t be as big. But yes, it would be embarrassing for Biden to ask the Saudis, Venezuelans or Iranians to increase production!

LP: What about the idea that the US could provide liquefied natural gas (LNG) to help Europe break energy ties with Russia? How feasible is this given the need for infrastructure, ships, etc.?

MA: Well, let’s look at the numbers. Nord Stream 1 is a gas pipeline from Russia to Germany with an annual gas capacity of approximately 55 billion cubic meters. Nord Stream 2 [under construction and almost finished, but awaiting regulatory approval] It could have doubled the capacity to 110, but it’s now on the shelves. Right now, I think there are only about 300 ships that have access to LNG, and only about half of them are operating at any given time.The largest ship built by the Koreans can carry about 250,000 cubic meters of LNG [gas converted to liquid]. This is not enough. You need more boats. On top of that, U.S. ports are mostly located on the Gulf Coast, making it a long journey to Europe. Then when you get to Europe, you need specialized terminals. It’s not like a boat dock and you’re ready to go – you have to convert the liquid back into natural gas. The only practical ports are in the Netherlands and the UK, so Germany would have to build LNG ports in the North Sea or the Baltic Sea to receive these large ships.

In Germany, large-scale energy development is decommissioning nuclear power plants, at least to generate electricity. I think they might shelve it for now. In the UK, the price of LNG, or natural gas, has risen sharply. Even in the US, our prices have gone up significantly. I can see it on the New Jersey bill, especially shipping.

LP: With all of these issues you mentioned, it sounds like the U.S. plan to supply LNG to Europe isn’t going to go very far in the short term. That means high prices in Europe will continue for a while, right? What about America?

MA: Yes, prices are likely to remain high in Europe and there is no real excess capacity in the US to ship out. Here, LNG currently accounts for about 40% of electricity generation, or a little bit more, so if you start exporting and you don’t invest in building something new, the supply-demand ratio in the U.S. will go up, which means our prices will go up. This means that inflation will rise.I’m not sure how they will fix it Thatquestion. If on the one hand you say that there is no more new stuff, no capital investment, etc., or you discourage them, but on the other hand, you want to export LNG, you have a dilemma.

LP: Let’s discuss the extent to which the oil futures market or the commodity futures market affects prices. In the US, prior to 2006, we had rules restricting transactions and who could do it. You can have futures contracts—farmers need them to sell crops at fixed prices, etc.—but producers and users dominate the market, not Wall Street players, who are limited by how much they can buy. But in 2006, the US lifted the position limit rule. Now Wall Street has bought into fuel futures — private equity, hedge funds, and more. Is this a problem?

MA: There is no doubt that hedgers and speculators just look at contract volume and it will have an impact. I think about 1 billion barrels of oil are traded or changed hands every day, and the actual production is only about 9-100 million barrels. Therefore, the ratio of futures barrels to actual physical barrels is ten to one.

There are two types of players in the market. Hedgers participate in the spot market, where delivery is instant. Speculators deal with the futures market, where delivery expires.

The spot market is influenced by traders – the big players in oil are Glencore and Vitol. They are the middlemen who get the oil from the oil producers and they do have huge influence.

Speculators like private equity people influence forward contracts and do not participate in the spot market. Crude oil futures market prices have an impact on the international crude oil spot market. Crude oil futures prices are affected by supply and demand fundamentals and external factors such as emergencies, policy uncertainty, and wars.

Futures really come into play in two situations. One is called a “contango,” and you buy futures that are usually higher than the stock price. That’s because people think about storage, insurance, etc. The future premium is higher than the current share price. Then you have the opposite situation, called a “reversal,” where you have a lot of stuff on hand and the future price is lower than the stock price. Most of the time the futures market is in contango, but sometimes, for example, if the stock is full, you may get back in cash. The whole chain goes from the oil producer to the middleman and then to the user – the refinery or the electricity producer.

Interestingly, in 2020, oil prices plummeted and actually turned negative, as a lot of people with contracts couldn’t unload because storage was near capacity. They had to pick up, but there was nowhere to store it and they got caught. The contract was up and they had to pay people to take it away from them.

The commodity market that could affect fuel prices is not just oil, but also metals. Green energy is metal based – it is steel, aluminium, rare earth metals etc. We are trying to move from hydrocarbons to metals, but the extraction of those metals requires hydrocarbons – fossil fuels.

China currently owns about 80% of the rare earth market production, so in the green energy scenario, we may increase our reliance on China.then lithium [needed for batteries for everything from electric cars to cell phones], from Bolivia, Argentina and Chile. But 70 percent of batteries are made in China, which already buys most of the lithium. There is also cobalt from the Democratic Republic of Congo, which has a monopoly on mining, production and processing. So your electricity and battery storage depend on China. And the production of green energy, be it windmills or solar power, is also heavily dependent on China. Electric vehicles in particular rely on rare earth elements – again China.

LP: Do we need to rework the rules to stop some of the guesswork, as we did before 2006?

MA: Regulation may require globalization, not just Wall Street. Some claim that speculation won’t have much of an impact on prices. I do not believe. If the ratio between trades and physicals is ten to one, then there will definitely be an impact. People like Southwest Airlines are very good at hedging because jet fuel accounts for 15-20% of their cost, but current price increases could make fuel cost a larger percentage of overall operating costs. They always buy these futures contracts to avoid being hit by higher prices. This is a good thing. These are users.But when you have speculators buying contracts, you can have a problem similar to what we had at AIG in 2008 – the whole problem [credit default] Swap played an important role in the financial crisis. The borrower buys the swap from the lender, but others unrelated to the transaction bet that the borrower won’t be able to pay, which is speculative. It was a big bang.

LP: The future is always uncertain, but what do you think about where we are going? Is there anything to be optimistic about prices and inflation? What about sustainable energy?

MA: Well, are we going from $100 to $80 a barrel, or back to $40? I don’t believe we’re going back to $40. I think we could be in trouble for a while (+-20% trading range subject to geopolitics and speculation). It will affect the price of electricity, and of course the production of almost anything requires energy – a lot of things are made of plastic. People also forget about ammonia and its relationship to natural gas. Ammonia, which is used in fertilizers, is made from natural gas, and Russia is a major producer of natural gas. Between Russia and Ukraine, they produce a lot of wheat for developing countries. Here again we have the difficulty of getting rid of hydrocarbons. We need better sustainable energy innovation than today. It may be small nuclear power plants, but they are very expensive. Another idea that you’re starting to hear from BP is hydrogen. But hydrogen has different colors. The color is green hydrogen, which is made by electrolyzing water using clean electricity from surplus renewable energy sources such as solar or wind. There’s also blue hydrogen (carbon capture), which is somewhat eco-friendly and is mostly produced from natural gas, but requires heat and hydrocarbons to separate it from other elements. There’s also grey, the most non-renewable form without greenhouse gas capture, which comes from natural gas or methane.

I hope we can get more innovation in sustainable energy, but the road ahead is tough. The best scenario is a hybrid model – maybe we can eventually go from 90% fossil fuel and 10% green energy to 30% fossil fuel and 70% green energy. But it’s still a mix. Fossil fuels are not disappearing from the picture.