Creative Destruction?

Question:  

What do you think about OPEC’s decision to reduce oil production?

Answer:

Before addressing this question, our Marco team would like to extend heartfelt compassion, prayers, and wishes for healing and peace to all who experienced the destruction of Hurricane Ian.

Supporting the community where we live and work by assisting with relief efforts is our foremost focus. Raymond James leadership team, advisors, and associates donated substantial amounts to the Florida Disaster Fund and other organizations and will continue to do so. If you are philanthropically inclined and have an organization you’d like to donate to, we can help facilitate this desire with a personalized Donor Advised Fund. Marco (and Naples) Strong!

Back to your question: The decision by the OPEC+ (Organization of the Petroleum Exporting Countries, including Russia) to decrease petroleum production by two million barrels per day is disappointing and will make the Fed’s job of lowering inflation more difficult. Increasing energy costs could put further pressure on inflation. It’s not just gas prices, but household energy prices that will impact consumers.

Before the Russian invasion of Ukraine, oil was about $125 per barrel. Petroleum prices of approximately $80 per barrel don’t appear to be high enough of the OPEC+ countries, causing them to decrease production and increase pricing. 

An unintended consequence of this is faster adaptation to technology that relies less on fossil fuels. The oil industry is not likely to accept its demise without putting up a fight. Creative destruction is a phrase coined by the late Austrian Economist Joseph Schumpeter that is defined as the “process of industrial mutation that incessantly revolutionizes the economic structure from within, destroying the old and creating a new one.”

The OPEC+ cartel’s action may be shortsighted at a time when many countries are moving towards reducing oil consumption by adding solar and wind energy while increasing adaptation of electric vehicle use. New technologies threaten older technology but aren’t a reason to abandon oil.

Cartels are illegal in the U.S. for good reasons, and the OPEC+ is indeed a cartel. The main problem is that they artificially control the quantity of a good that is produced to set the price of that good. By doing this, they can command higher profits for the industry and reduce supply, keeping the commodity from the consumer favoring companies over the end users. 

Cartels know that the higher they set the price, the more incentive there will be for other emerging technologies to evolve and threaten their ability to increase profits. The higher the price, the more intense and quicker the process of creative destruction. The cartel should not blame others for what is clearly their own undoing driven by short term profit motives.

The Federal Reserve (Fed) is expected to raise rates again in November and December, possibly ending the year as high as 4.25% - 4.50%. But will this be enough to ease inflation, especially if energy prices increase? The Fed’s inflation target is 2% and the remaining rate hikes are expected to bring inflation down to this level. The Fed needs to be patient and not raise rates so high as to send the U.S. economy into a deep, rather than then a milder anticipated recession.

Strong employment numbers indicate a tight labor market, which is another deterrent to lowering inflation. Unemployment at 3.5% is great for the economy and labor market yet keeps pressure on firms to increase wages which keeps prices higher. Fed Chairman Jay Powell said in August that “without price stability we will not achieve a sustained period of strong labor market conditions that benefit all.” Higher oil prices are not expected to help ease inflation, which is crucial for consumers, especially as we rebuild after Hurricane Ian. Stay focused and plan accordingly. 

Source: FactSet, data as of 9/30/2022