Teetering or Tottering

Part 2 – Balancing oil markets with U.S. policy?

By John Eichberger | June 2017

The last time we took a stroll through the park to see what was happening on the playground of fuel prices. This time, let’s climb higher and look around – what is truly influencing the up and down of the teeter-totter that consumers are riding.

For this discussion, I want to focus on oil, which is the primary force affecting the direction of the teeter-totter. It represents on average more than 60% of the retail price of gasoline. So, when oil prices go up, the teeter-totter goes with them. But what is influencing the direction of movement? The oil market is incredibly diverse with too many players and influencing factors to really develop a comprehensive overview in such a small space. So, let’s isolate and focus on one critical factor - U.S. policy.

Working to push the teeter-totter side down are administration policies affecting domestic oil production. Supporting Keystone and Dakota Access Pipeline projects, opening offshore oil production and expanding domestic energy production puts the U.S. into a position to have a growing influence on global markets. Increased domestic production can put downward pressure on increasing global prices, especially now that the U.S. is exporting oil into the global market.

However, working to prop the teeter-totter up are those who do not like low oil prices. OPEC is working to cut production in an effort to drive prices higher and several non-OPEC nations have been cooperating with them. Their economies depend on higher oil prices, and perhaps none more so than Russia. And when Russia needs something that the global market seems disinclined to provide, its neighbors start getting nervous (but that is another story).

Enter into the equation an unlikely potential ally of those seeking higher oil prices – U.S. foreign policy.

The price of oil is determined primarily by traders on Wall Street buying and selling futures contracts. These prices are based upon actual and anticipated changes in supply and demand. We have learned that military conflicts in the Persian Gulf region lead to increased volatility in the markets. If more assertive policy initiatives of the U.S. lead to increased tension in oil producing regions of the world (or prompt a more assertive foreign policy by Russia), it is conceivable that this tension would exert upward pressure on oil markets.

So, which kid – domestic policy or foreign policy - is heavier? The answer is not immediately clear, but whichever way the oil market teeters or totters, retail gasoline prices will ultimately follow.

This playground metaphor, while perhaps antiquated, is real – if global unrest yields higher oil prices, the incentive for domestic production increases. The introduction of more North American oil into the global market could yield lower oil prices, with the net effect being relative stability in the fuels market. Who wins?

If the two forces acting on the teeter-totter are equal, the consumer will prevail and continue to enjoy relatively low fuel prices. It is conceivable that U.S. production can be increased sufficiently to offset upward price pressure exerted by global tensions, thereby limiting the upward potential of the oil market and protecting consumers from a significant run up in price. (Unless other domestic policies, such as protective trade measures, exerts upward pressure on the market.) In a market that might be stable at current prices, consumers will remain happy and non-fuel spending should stay strong.

By contrast, in a stable market alternative fuels and technologies will struggle if they do not improve their value proposition to convince consumers to make the switch. This dynamic is likely to slow their pace of market penetration but will ultimately make them better and more competitive. Once again, this could yield significant consumer benefits. Once alternative powertrains are competitive with traditional vehicles, they will be able to compete on their merits rather than relying upon the fickle fuel market for survival.

On the playground, it really doesn’t matter which way the teeter totters – both kids have fun. Maybe in this metaphor, the consumers are the kids and, if neither of the competing forces in the oil market gain a significant advantage, the consumer could reap the benefits. Only time will tell which carries more influence – domestic or foreign policy.