Saudi Arabia, U.S. Frackers, and U.S. Margin Debt

Posted February 22, 2022

The Unsuspecting Drivers of U.S. Inflation and Market Volatility

As U.S consumers continue to feel the pinch of rising costs on everything from food, gasoline, apparel, home furnishings, and travel, inflation increased 7.5% in January 2022 from one year prior. Record inflation has brought with it market volatility and geopolitical instability that we have not experienced in 2-years, since the Covid crash.

The largest single category driving inflation and geopolitical instability is gasoline and crude oil which is up 40% in January 2022 from one-year prior. Russia, which provides about 10% of the world’s oil, has taken advantage of the increase in state revenues to help buffer the impact of U.S. and NATO sanctions should they choose to continue forward with their military offensive in Ukraine. Looking beyond the daily news headlines, you will find 3 unsuspecting drivers of U.S. inflation and market volatility: Saudi Arabia, U.S. Frackers, and U.S. Margin Debt.

Saudi Arabia

Rising oil prices and an impending Russian invasion of Ukraine have put Saudi Arabia in a political bind when it comes to doing its part to ease global inflationary pressures and geopolitical tensions. President Biden has repeatedly called upon OPEC producers to pump more oil to reduce prices. The calls are becoming more urgent as prices for crude oil approached $100 a barrel. The Saudis have responded by refusing to pump more oil. Instead, they are standing by a 5-year-old oil alliance between Russia and OPEC called OPEC+ that is helping Russia increase state oil revenues at the expense of rising inflation and market volatility in the United States.

U.S. Frackers

The top 3 shale oil frackers in the U.S. reported their highest annual profits in over a decade last week, but they too plan to keep oil production low in 2022. The Biden administration has asked U.S. oil producers to drill more as it faces rising oil prices driving broad inflation. Pioneer Resources, Continental Resources, and Devon Energy are instead agreeing to adhere to their agreement with Wall Street and return more cash to shareholders in an effort to win back the trust of investors who fled oil investments after years of subpar returns.

U.S. Margin Debt

The rise in inflationary pressures over the prior year coupled with the global geopolitical instability has given rise to another unsuspecting driver of market volatility, U.S. Margin Debt. As evidenced by the FINRA margin debt chart below, margin account balances have nearly doubled since the start of the Covid-19 pandemic. As valuations compress over concerns of inflation and geopolitical risks, investors are forced to sell down their positions to cover their margin obligations. This cycle of valuation compression and forced margin selling continues to exacerbate market volatility

In Summary …

Multiple coinciding drivers are exacerbating the rising inflation of energy costs, which makes up a large part of consumer spending. Demand for oil has returned to pre-pandemic levels but we are now faced with a supply shortage driven by three major reasons.

1. OPEC’s unwillingness to increase output (which in the long term may be a strategy to expand their global market share).
2. After the shale revolution’s grossly overoptimistic decline curves, coupled with unrelenting ESG pressures, oil producers are focusing more on returning cash to investors to bolster confidence in the capital markets than they are on drilling and exploration to replace diminished supply.
3. Over the past decade, the Oil Majors have steadily shrunk their capital spending budgets foregoing investments in oil explorations which is now culminating in their inability to keep up with reserve replacement. 

As a result, the energy markets have entered a bull market of rising prices that may last for a long time.

Joe Maas, CIO | CFA, CFP®, ChFC, CLU®, MSFS, CVA, ABAR, CM&AA, CCIM
David Stryzewski, CEO | CSA, NSSA