June Energy Prices Insights—Tim Pierotti, Chief Investment Strategist
Tim Pierotti, Chief Investment Strategist
This week, we focused on trying to better understand the potential durability of higher energy prices.
As a reminder, at WealthVest, we have a long-term view that potential GDP growth is going lower. That means, we see a real GDP growth rate that will average below 2% and an inflation backdrop that will be consistently problematic, quite unlike the grinding decline of inflation over the last four decades. For what it's worth, this is an increasingly non-controversial view among academic economists, but not one that is yet embraced more broadly on Wall Street.
While much of our view is driven by slowing demographics, lower productivity and cumulative debt, energy inflation is also an important driver and obviously topical today with US gasoline pushing over $5.
Where we offer a variant view on energy inflation is on the question of durability. Simply put, the energy industry, after 10 years of falling capital expenditures has shifted even further to capital starvation mode and we think the long-term outcome will be chronic global spare production capacity shortages, and perhaps more acutely, a chronic shortage of US refining capacity.
The refining industry specifically has not been an easy way to make money over the span of my 25 year career. The industry has been, at times oversupplied, inherently cyclical and massively capital intensive. Now, in a world where every year electric vehicles will comprise a larger and larger percentage of new cars sold, the refining industry foresees a future of falling gasoline demand. The industry is doing the only rational thing it can do: bleed the business for cash.
We are simply NEVER adding more US refining capacity. I spoke to half a dozen energy analysts, PM's and traders this week and not one of them pushed back on the thesis that the capacity ceiling will only go one way as the industry is run for cash in perpetuity.
For the ten years preceding the pandemic, US refining capacity basically went sideways averaging 18.2mbpd (million barrels per day). In 2020, refining capacity hit a decade high of 19mbpd. Now, as we emerge from the pandemic, US refining capacity is 17.3mbpd and I can't find anyone who thinks it has a chance of going a tick higher. Capital spending among the independent US refiners has fallen 50% since just 2019.
To be clear, the point we are making is not that you should go buy refining company stocks given that there is a finite future for the industry as well as the non trivial issue that we appear headed for a near-term recession. Our point is that, while we are going to see demand destruction and likely near-term lower product prices, we are going to see structurally higher oil product prices long-term as the refining industry essentially shrinks and steers FCF cash to investors.
The US and the world has no option but to address climate change through decarbonization, but there will be painful unintended consequences along the way. The capital starvation of the refining industry is one of them. The problem isn't going away and the result is just one more long-term upward pressure on inflation.
For more from Tim listen to our weekly podcast, WealthVest: The Weekly Bull & Bear here.
Tim Pierotti is WealthVest’s Chief Investment Strategist.
Tim has over 25 years of experience in various aspects of the equities business. Prior to joining WealthVest, Mr. Pierotti spent seven years in Equity Research management roles at Deutsche Bank and most recently at BMO where he was a Managing Director and Head of US Product Management. Tim has 11 years of investment experience most notably as Head of Consumer Research and Portfolio Manager at The Galleon Group, a former NY based $8Bln Long/Short hedge fund. Tim is a graduate of Boston College and lives in Summit NJ.
