American Oil and Gas Reporter - January 2023 - 45

Outlook 2023
Lenders Adjust For Instability, Inflation
By Jason Reimbold
For the first time in 40 years, the U.S. economy, and every
other major developed economy, is facing significant inflation.
Rather than raising rates to fight potential inflation, the U.S.
Federal Reserve spent much of 2022 raising rates in hopes of
suppressing inflation.
Much of what brought us to this point has been years in the
making, though some of these imbalances accelerated because
of the Covid-19 recession and recovery, during which policymakers
injected unprecedented monetary and fiscal stimulus into
economies across the globe.
These imbalances are challenging some of the basic economic
and market tenets that have been in place for decades.
Costs, Wages, Labor
As we enter 2023, our analysts have a few expectations:
Achieving a 2.0% inflation rate may prove impossible. Economic
growth is slow and there is a significant chance of a recession in
2023. Labor markets may not be hit quite as hard as they have
been during prior recessions.
We know costs, wages and labor will continue to be pain
points for nearly every U.S industry:
· Companies' margins may shrink as manufacturing is rehomed
to more favorable partners.
· One source of inflation has been higher wages, which
may become more structural as higher paying manufacturing
jobs return to the United States.
· Markets may not be hit as hard compared with prior recessions,
as job openings still exceed available labor by more
than three to one as we enter 2023.
Of course, the oil and gas industry is not immune to these
economic conditions. The sector saw escalating drilling and
service costs throughout 2022. Moreover, both labor and equipment
shortages have made it increasingly difficult to execute nearterm
development plans, requiring many companies to schedule
services six months, or more, in advance. These conditions,
combined with commodity price volatility, make capital budgeting
decisions very difficult, which sidelines or curtails some exploration
and production companies' drilling programs.
Zooming out a bit, we know Russia's invasion of Ukraine
will impact oil and gas markets-and therefore the overall
economy and markets at large.
Russia is the number-two producer of both oil and gas in the
world. Roughly 70% of the oil Russia produces is exported in
the form of either crude oil or crude oil products. Russia also
has been the largest supplier of natural gas to the European
Union. Here is what we know at the beginning of 2023:
· The disruption of the Nord Stream 1 and 2 pipelines
could impact European energy supplies for many years.
· Global uncertainty as to how Russian oil barrels reach the
market also will have an impact.
· An increased focus on environmental, social and governance
considerations has slowed investment in fossil fuels as capital
has become scarcer and companies seek to return capital to
shareholders.
· Energy security appears to be shifting, with OPEC-plus
cutting production despite the Biden administration's protests,
which signals a shift toward Chinese-Russian interests.
· Global liquefied natural gas will contribute to the solution,
which should benefit the United States, Qatar and Australia as
low-cost natural gas producers with an ability to export, but the
overall global benefit will occur over a longer period.
Climbing Capital Costs
Inflation likely will continue to be both better and worse
than the data shows. The Federal Reserve's rate hikes already
have zoomed past expert predictions. Including the most recent
increase, the Federal Open Market Committee has raised the
federal funds rate 4.25% since the start of last year. Entering
2022, we thought there would be two, maybe three Fed rate
hikes of 25 basis points each. Instead, the Fed has raised rates
significantly faster and further than anticipated because inflation
accelerated faster and further than expected.
Headline inflation was up 8.2% year-over-year and 0.4%
month-over-month in September, as measured by the consumer
price index. That is down from the end of June, when inflation
peaked at 9.1%-the largest 12-month increase in 40 years-
but still way too high.
CPI inflation data is released with a month lag, so actual inflation
may differ from the most recent data. The situation is
both better and worse depending on which part of the inflation
picture is under examination. For instance, prices for commodities
such as lumber, steel and copper are dropping. Even the initial
price surge in agricultural commodities such as wheat, corn and
cotton have backed off a bit.
The trading volume and open interest (number of open outstanding
contracts) in both NYMEX WTI and Brent crude
futures have dropped substantially, creating wild price swings
that mostly are attributable to the Ukrainian war and China's
JANUARY 2023 45
American Oil and Gas Reporter - January 2023

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