President Donald Trump’s love of coal, rejection of climate science and disdain for things like fuel efficiency hark back to a smokier, smudgier era. Yet if this year has shown anything, he is one of the biggest disruptors in energy. He just does a different kind of disruption.
In a prescient essay published late last year, Jason Bordoff, founder of the Center on Global Energy Policy, wrote that Trump’s energy-specific policies would have less of an impact than his broader shifts in foreign and domestic policy. One look at the minimal impact of efforts to revive coal mining suggests Bordoff was on to something. When it comes to Trump and energy, macro trumps micro.
As outgoing Defense Secretary James Mattis put with skewering politeness in his resignation letter, Trump personifies what you could call a profound shift in U.S. foreign relations. The prior constants of free trade and security guarantees underwritten by the U.S. were the product of a Cold War that ended three decades ago. See this column for a more detailed discussion, but suffice to say the post-1945 order that nurtured the world’s energy markets is now being challenged by its chief sponsor.
The shale boom – along with less-ballyhooed gains in energy efficiency – has emboldened the U.S. in this regard. America’s old approach was to “bring the rest of the world with it” in terms of energy security, says Sarah Ladislaw, senior vice president at the Center for Strategic & International Studies. Now, it is “less about shared common goods and more about dominance.” Or, as Peter Zeihan, a geopolitics strategist who has written extensively on this theme, puts it: “Disruption in global energy is a feature, not a bug, of U.S. policy.”
Take, for example, Twitter. Discreet calls to nudge foreign oil producers? Trump’s tweets dispense with such niceties. They are real-time, broadcast interventions in the world’s biggest commodity market by the leader of the world’s biggest producer and consumer of the stuff. They don’t alter physical supply and demand per se. But they affect expectations and, therefore, prices – and, therefore, supply and demand. Especially as their author has the means to really intervene with something like, say, sanctions on Iran.
This captures the central drama that ripped through the oil market this summer and fall. Ahead of the midterms, Trump tweeted repeatedly against rising oil prices, and Saudi Arabia and others raised production. Like many, they were counting down the days to new sanctions on Iran – a big reason why prices had risen in the first place – scheduled for early November. By then, though, signs of excess supply were knocking prices already, and news of sanctions waivers touched off a rout arrested briefly by OPEC’s renewed supply cuts.
While Trump’s tweets are real-time, another all-American innovation, fracking, also reacts to prices relatively quickly. This marriage of short-cycle shale production with even shorter-cycle volleys from the White House is a genuinely disruptive development. Shale effectively narrows the price-band in which OPEC tries to manage the oil market, while Trump’s tweets can drown out the likes of Saudi Arabia when they try to talk up prices or get immediate credit for promised supply cuts.
When the rules of the game change, some players just up and leave. This time last year, I was writing about the exit of Andy Hall, the veteran oil trader nicknamed “God” who closed down his main hedge fund, citing the disruption of elastic shale output and algorithmic trading. More energy-related hedge funds have either called it quits or suffered extreme whiplash this year.
Energy’s weighting in the S&P 500 is now less than 5.4 percent, the lowest in 15 years. Even pipeline stocks, which in theory should be benefiting from higher volume and efforts to clean up balance sheets and governance, have slumped again. Option-adjusted spreads on energy junk bonds have risen back toward 600 basis points for the first time since late 2016. Meanwhile, open interest in oil futures has plummeted.
Withdrawal creates its own side effects. In a series of recent reports, energy economist Phil Verleger argues persuasively that the recent sell-off in oil was exacerbated by the concentration of hedging by U.S. frackers in the $50 to $60 a barrel range. As oil prices fell through these levels, so swap dealers on the other side of those trades had to sell more futures to manage their own risk, intensifying the collapse. If the upshot is that exploration and production firms find it harder to hedge on good terms, this could ultimately curb production growth.
That holds out the tantalizing prospect of another turn in the cycle as supply falters. But, hold on, another turn already? The shortening of the cycle is itself an impediment to tempting dollars back into the sector. And besides algos and shale, all sorts of things have unmoored long-held certainties. OPEC’s power seems to diminish in inverse proportion to the number of countries it invites to Vienna, and Saudi Arabia is undergoing a jarring – and sometimes deadly – generational power shift. Rising renewables and electrification are eroding the walls separating energy’s fiefdoms, such as oil in road transportation. Demand for energy in general is becoming decoupled from economic growth. And lest we forget, the Federal Reserve is sounding the bell on the past decade’s reliable “buy the dip” approach on everything, not just energy.
Then there is Trump. Besides Iran and the tweets, the trade war with China looms very large over all commodities. Given the deep-seated issues at stake and evident antipathy, the current truce feels more like a pause than a prelude to imminent peace.
What could make 2019 even more volatile on this front is the changed context Trump confronts. Come January, most of the old hands surrounding him in his first two years will have departed (with Mattis leaving soon after). He will suddenly face an antagonistic House even as the Special Counsel’s investigation rumbles on, louder than ever. And he will begin his 2020 election campaign, potentially against a backdrop of a volatile stock market and other signs of a slowing economy.
In responding to such pressures, and facing a gridlocked Congress, it will be tempting to reach for those executive levers centered on foreign and trade policy. If it felt like energy’s world was rocked in 2018, it’s quite possible next year will trump that.