The Known Unknown

So far, the sea-change in equity and bond market environments that contributed to routs in September have continued in October. We have gone from TINA (There is no alternative to equities) and “Cash is Trash,” to an environment where treasury bills are among the best performing assets.  When rates move aggressively, the likelihood of some unexpected financial instrument breaking is high. In September, it was the British Pound, which neither we nor anyone else forecast.  In interconnected systems, small sparks can ignite significant fires. We expect the Federal Reserve will come under pressure to pause rate increases given the damage they have had on the world economy.  So far, it looks like they are continuing their stated course.

Count among the known unknowns versus the unknown unknowns, we have entered a period where there isn’t a lot of visibility.  No one expected a 2.0 million per day proposed cut from OPEC, although the KSA has been vocal about wanting to maintain a price floor. Tanker equities, both product and crude, dropped on Wednesday, at some points dramatically after OPEC announced their decision to reduce production.  Equity prices recovered on Thursday, as investors realized that if the Europe sanctions went into effect, the ton miles would increase, more dramatically for product tankers and likely crude tankers as well.  It is not so much looking at shipping at this moment, but shipping plus geopolitics. For example, if the US bans refined product exports to reduce prices for US consumers, it would likely dramatically increase product tanker rates, as South America would need to be supplied from Russia and China rather than the US. 

We are transitioning from a world that has benefited from a decade of cheap and plentiful electricity, natural gas, and oil to one that will experience more crises due to increasing costs. Governments have prematurely cut off investment in conventional energy but have insufficiently invested in decarbonized energy infrastructure to offset it. While the EU clearly is impacted by a lack of Russian gas deliveries and future sanctions, the negative impacts of underinvestment in existing conventional energy and of too rapid decarbonization will be felt in the US and Asia as well. We have seen instance after instance of poor planning.  Average gasoline prices in California are 66% more expensive than the national average.  It is a combination of taxes, seasonal maintenance, California’s cap and trade program, low carbon fuel standard, and climate regulations to shut down or convert refining capacity to producing biofuels. Today, there is just insufficient refining capacity for California’s demand.  It’s been a windfall for California refiners as the gross profit on gasoline in Los Angeles is $101 per barrel of oil vs. $6.60 on the Gulf Coast.  Globally, oil depletes over time and needs to be replaced with exploration, which has been insufficient since 2014. We don’t know when Western politicians will recognize the long-term inflationary cost of rapid decarbonization, but at some point, an unknown unknown will become a known known, for better or worse. Until then, the chances of unforced errors when it comes to energy is significant.