American Oil and Gas Reporter - October 2022 - 32

WTI Prices Could Bolt Higher
As Fed Seeks To Cool Inflation
By Ryan Dusek
HOUSTON-As the third quarter begins, the markets are
being roiled by a litany of factors-the aftermath of hurricane
devastation in Florida, a stock market in retreat, an increasingly
gloomy economic outlook, the sabotage of Russian natural gas
pipeline infrastructure offshore Europe, the ongoing war in
Ukraine, and of course, historic levels of inflation.
To the latter point, it's astounding how quickly things have
changed. Just a year ago, the Federal Open Market Committee
(FOMC) gave a picturesque view of the economy. Any inflation
was " transitory " and would likely fall to 2% in 2022. The
federal funds rate would remain lower longer with little chance
of a recession.
At that same time, we had a different point of view. Given
the weak U.S. dollar, cheap money and the U.S. Federal
Reserve's oversized balance sheet, it was inevitable that inflation
would occur. And it most definitely has, with U.S. inflation at
the highest levels since the early 1980s.
Now, with the inflation rate above 8.0%, the FOMC is
playing catchup with one of the fastest Fed funds rate increases
on record. On Sept. 21, the Fed raised its interest rate by 75
basis points for the third time this year to a 3.00-3.25% range
and signaled more large increases to come.
The Fed obviously is aiming interest rate hikes at combating
inflation, but will ancillary factors affecting West Texas Intermediate
crude oil demand and prices add fuel to the fire? More
to the point, is WTI recession proof?
This rapid increase in interest rates certainly will have conImplied
Overnight Rate & Number of Hikes/Cuts
FIGURE 1
4.8
4.6
4.4
4.2
4.0
3.8
3.6
3.4
3.2
3.0
Current
6.0
5.0
3.0
4.0
Number of Hikes/Cuts Priced In
Implied Policy Rate (%)
12/14/2022
05/03/2023
09/20/2023
32 THE AMERICAN OIL & GAS REPORTER
01/31/2024
1.0
2.0
0.0
sequences. The U.S. dollar currency index (DXY) has continued
to strengthen. A stronger U.S. dollar makes dollar-denominated
commodities such as U.S. benchmark WTI crude oil relatively
more expensive for holders of other currencies.
That being said, U.S. corporations not actively hedging their
foreign currency exposure will take a hit in earnings. After continued
periods of steady decline in the dollar, this recent interest
rate shock is being felt around the world. This new market will
test companies' assumptions about the forex portfolio, another
area that equity and debt investors will need to monitor.
Expectations For WTI
With the focus shifted to the FOMC, crude oil demand destruction
has taken center stage. The inversion of the yield
curve (two-year treasury trading higher than 10-year) is a strong
indicator of a looming recession. The spread was at -0.41% on
Sept. 22, compared with +1.07% the same time last year (this is
lower than the long-term average of 0.92%).
Economic growth has slowed more than estimated and the
equity markets continue to struggle, with the broader S&P
index down 24% year to date. Figure 1 shows the implied
policy rate, which currently peaks in May 2023 at slightly over
4.6%. The elevated rates are expected to persist well into 2025.
Given the FOMC's guidance for higher rates over the next four
years, we are barely in the second inning of this game.
Although demand destruction is real, the larger issues reside
on the supply side. Fundamentally, the energy complex has been
under attack. Between politicians wagging fingers and blaming
chief executive officers for higher oil and gas prices and new environmental,
social and governance initiatives impeding new
fossil fuel development, U.S. crude production is waning and
likely will be slow to respond to any type of supply shortage.
Major headwinds include:
· Government spending programs. The deceptively named
" Inflation Reduction Act " only adds fuel to the fire. Chasing a
carbon-free agenda is expensive and results in higher costs with
less reliability. Additionally, providing more stimulus to an
already inflated economy will not end well.
· Restrictive fossil fuel energy policies. In addition to
higher costs, replacing fossil fuels with renewables without established
infrastructure creates storage, transmission and reliability
issues, especially in geographies where it is needed most (e.g.,
rural America).
Number of Hikes/Cuts Priced In
Implied Policy Rate (%)
American Oil and Gas Reporter - October 2022

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