Figure 1.
Rigs and Spreads April 26: Unchanged
The US oil business remains as uneventful as I have seen it since I started covering the sector 17 years ago. Very little has changed since last September, including rig and spread counts and oil production. It’s frankly a bit strange in an industry characterized by massive swings, both up and down. Of course, stability is preferable. Nevertheless, the history of oil tells us that it is unlikely to last too long.
Rig counts
Total oil rig counts: -5 to 506
Horizontal oil rig counts: -2 to 457
Frac spreads: -3 to 257
DUC inventory has largely stabilized at 16 weeks of turnover
The Alternative is sinking Russian Tankers
It's been a wild week. Over the weekend, Iran unleashed a barrage of missiles on Israel; the world awaits the response. President Trump is in the dock, in a criminal trial he looks set to lose. Speaker Johnson finally appears ready to introduce various funding bills for Ukraine, Israel and Taiwan, even as the Clown Show tries to take him down. And meanwhile, the US Secretary of Defense, Lloyd Austin, admonished Ukraine to observe proprieties and not make waves as the country fights for its life. The US appreciates that the situation may be desperate, but for goodness sake, please do it quietly! Those attacks on Russia refineries could increase fuel prices and inconvenience all of us.
Ukraine has been facing the twin challenges of an excessively timid Biden administration and a wildly dysfunctional Republican conference in the House. Barring a vote to fund Ukraine this weekend -- and even with it at some point -- Ukraine may be compelled to try to restrict Russian oil exports through the Black Sea. A combination of Russian, western and other tankers export almost $10 billion of Russian crude from the Black Sea every month. That equals the entirety of Russia's defense budget. The oil continues to flow only because the US and western Europe so desire. In essence, the US is protecting Russian oil exports and allowing Russia to fund the war thereby.
Ending this trade would materially degrade Russia's ability to conduct the war. It would also raise oil prices comfortably to $150, and perhaps as high as $200, per barrel. This would push Europe into a steep recession and would similarly punish US consumers. Indeed, US drivers would lose $60 bn / month in added gasoline and diesel costs, with the price of regular gasoline reaching perhaps $6 / gallon ($8 in California). US government support of $60 bn for Ukraine for the entire year would look like peanuts by comparison.
Should that happen, Kyiv would be in a position to shift the blame firmly onto the MAGA Republicans in Congress. Does Marjorie Taylor Greene prefer $6 gasoline to supporting Ukraine? Kyiv can put her to the test.
A strike on a Russian tanker would also panic the White House, prompting a swift and desperately needed restructuring of the Price Cap. Ukraine will not win the war without it.
Attacking Russian tankers is, of course, a politically risky option. A very risky option. On the other hand, certain defeat at the hands of the Russians is a much higher price to pay. If push comes to shove, the Ukrainians need to shove. Marjorie Taylor Greene and the MAGA Republicans need to decide if they want to own $6 unleaded as the Ukraine vote reaches the House floor.
Oil Prices
Brent crested $90 last week, but is trading down a bit, $87 at writing. Nevertheless, copper prices continue to surge. Thus, either copper has to retrace, or Brent might be expected to rise to $96 / barrel.
Urals has closed up, much as expected, to $78 / barrel, $18 / barrel above the Price Cap.
The Urals discount, the difference between Russia's western crude oil export price and Brent, has compressed to around $11 / barrel, again, much as expected.
Urals is now at the highest level for this date in at least nine years.
Despite US fretting, European gasoline and diesel prices do not appear materially affected by Ukraine's attacks on Russian refineries.
Overall, oil prices are developing much as expected and against Ukraine's interest. The easiest, though high risk, way to motivate a desperately needed and vastly overdue restructuring of the Price Cap would be an attack on an oil tanker carrying Russian crude in the Black Sea. If the House fails to fund Ukraine and the White House declines to revisit the Price Cap, it might come down to that.
Not good.
Trends are running markedly against Ukraine this week. House Speaker Mike Johnson must put Ukraine funding on the table right now, as the situation is becoming critical. And Ukraine won't win the war without a restructuring of the Price Cap. That's the moral of the story for this week.
Oil Prices
Oil prices really took off this week, with Brent closing above $91 / barrel on Friday. This is the highest since September.
One might be tempted to attribute this wholly to Russian and OPEC+ supply production cuts, but in fact, it's not just oil. Copper has had an even better run, closing on Friday at $4.25 / lb, the highest in fifteen months. Copper and oil covary, and as such, copper is implying the 'fair value' of Brent should be about $93. Therefore, oil seems to have some upside potential. Taken together, oil and copper are indicative of a strong global economy.
China is the exception. Iron ore and steel prices are hovering near five years lows, although not at exceptionally low levels. Such prices are heavily influenced by Chinese real estate and infrastructure construction, and both are struggling just now.
In any event, oil prices are evolving as leading investment banks have anticipated. I would add that US shales will not come to the rescue this time, with the EIA forecasting largely flat US oil production over the next several months.
Following on the Brent rally, Russian oil prices are also showing life, with Urals closing the week above $75. The Urals discount, the difference between Russia's Urals oil export price and Brent, averaged nearly $16 / barrel for the week. This is likely the result of delays in reporting, and we might expect the discount to close back to $14, with a tendency towards $12. Urals at $80 / barrel is within sight.
Finally, the Urals price is not only well above the $60 Price Cap and rising, it is also testing nine-year highs. This is a lousy situation for Ukraine, but entirely predictable and the direct result of poor decision-making in both Washington and Kyiv.
Finally, EU fuel prices appear largely unaffected by Ukraine's continuing attacks on Russian refineries. Notwithstanding, expect gasoline and diesel prices to follow crude oil prices up, as is normally the case.
So, to sum up the takeaways: While Russian and OPEC supply cuts may be lifting oil prices, they are not the only factor. A strong global economy appears equally responsible, suggesting that oil prices could continue to rise, just as a number of analysts have been forecasting. Urals is already $15 above the Price Cap and $4 / barrel above the budget numbers used by the Russian central bank. The Urals discount is likely to compress further, pushing Urals closer to $80 over the next few weeks.
Meanwhile, the Ukrainians are running low on ammo and anti-aircraft missiles, just as the Russians have developed a more effective glide bomb and reports are surfacing about a 300,000 man assault by the Russians on Kharkiv. It's now or never for Speaker Johnson on Ukraine funding; and Washington and Kyiv had better start contemplating a near-term restructuring of the Price Cap if Ukraine is to prevail.
Putin: Oil to $100 to Elect Trump
JP Morgan strategists see "Brent crude heading toward $100 a barrel this year without countermeasures to balance Russia’s decision to cut production". As I noted last week, Russia looks to cut production by roughly 500,000 bpd, complementing OPEC cuts of similar size. Barron's notes:
“The shift in Russia’s strategy is surprising. At face value, and assuming no policy, supply or demand response, Russia’s actions could push Brent oil price to $90 already in April, reach mid-$90 by May and close to $100 in September, keeping pressure on the U.S. administration in the run-up to elections,” J.P. Morgan’s Natasha Kaneva said [in a note issued on Wednesday, March 27].
This is a curious, but not surprising, development. To date, the Kremlin has not pursued oil price maximization to finance the war. Therefore, the motivation now is likely different, and from the Kremlin's perspective, much more compelling. As Barron's and others point out, oil price increases appear designed to encourage US voters to reject Biden and elect Trump. This in turn reflects two implicit beliefs from Putin. First, the choice of US leader appears of paramount importance. That is, Putin believes Russia cannot defeat Ukraine unless the US abandons Kyiv. While this may be news in Republican circles, I have stated on several occasions that NATO's population is six times and its GDP is a staggering twenty-fives times that of Russia. Russia's taking on NATO would be akin to a 10 pound child taking on a 250 pound man. I take Putin as a reasonably intelligent man, and he appreciates Russia's odds are unfavorable if NATO, and in particular, the United States stands beside Ukraine. Electing Trump, therefore, is a key Kremlin priority.
Second, Putin appears to place supreme confidence in the actions of Trump were he re-elected. Why? Why would a Russian autocrat feel he can exercise absolute dominance over an elected US president? Why does Putin believe Trump and the US will be subservient to the Kremlin's wishes? When, in the entire history of the United States, did a US president crawl before a two-bit dictator?
Russia has been exploiting Republican paralysis in the US Congress to attack Ukraine at a murderous pace for the last six months, but at a high cost. According to Ukrainian official numbers, eliminated Russians now exceed 440,000, tank losses are approaching 7,000; armoured personnel carrier losses exceed 13,000; and more than 11.000 pieces of Russian artillery have been destroyed. Can Russia sustain this pace?
If one wants to assess the Kremlin's state of mind, there is no better source than Viktor Orbán, Hungary's Prime Minister and Putin's NATO mouthpiece. Last month, Orban suggested that Ukraine be left as a neutral buffer state between Russia and Europe. This can be taken as a Kremlin trial balloon to seek a settlement to the war. On March 15th, Putin added this:
"For us to hold negotiations now just because [the Ukrainians] are running out of ammunition would be ridiculous. Nevertheless, we are open to a serious discussion, and we are eager to resolve all conflicts, especially this one, by peaceful means."
In other words, Putin will discuss peace, but because the US is refusing to arm Ukraine, Putin wants better terms. Nevertheless, Putin is signalling that the war is beginning to wear Russia down. He is feeling for an exit, one which can only be achieved if the US abandons Kyiv. Therefore, Putin's strategy fundamentally depends on his influence over the Republican Party, and the Republican Party today is the creature of Donald Trump. As Putin feels confident in his ability to control Trump, re-electing Trump is central to Russian strategy. Hence the drive for $100 oil.
Some analysts have suggested the US could once again tap its strategic petroleum reserve to counteract Russian and OPEC+ production cuts. Is this feasible? The SPR was drawn at the pace of 1 mbpd in the early stages of the war, about as much as would be required to offset announced OPEC+ production cuts. As the graph below shows, such draws are not unprecedented, even in recent history.
Source: EIA
On the other hand, the SPR is depleted. The Biden administration has drawn down the reserve to only 55% of its normal levels. To counteract OPEC+ production cuts, we forecast the Biden administration would have to further reduce the SPR to about 200 million barrels, only ten days of US oil consumption and less than one-third of customary levels. In principle, this is possible. As a political matter, and more importantly, as a matter of prudent management, such draws appear problematic.
* Forecast assumes SPR is drawn at a pace of 1 mbpd to counteract Russian and OPEC+ oil supply cuts
Source: EIA, Princeton Policy forecasts
Importantly, the US would be drawing its strategic reserves even as massive amounts of excess crude are parked in the non-OECD countries, most notably China. As I noted earlier, excess crude inventories soared during the pandemic, largely owing to collapsed consumption. By late 2021, however, the US and other OECD countries had largely recovered, and inventories, as measured by days of turnover, had returned to normal levels. Not so in Asia. China's delayed re-opening kept excess inventories elevated, and the Russia-Ukraine war started before such excess crude inventories were fully run down. Instead, the Price Cap and Embargo offered an enormous incentive for Indian and Chinese traders to hoard oil, which they do to this day, to the tune of about 1 billion barrels above normal operating needs. Thus, the use of the SPR to counteract the Russia and OPEC+ production cuts would have the effect of gutting US strategic reserves even as Asia, and most notably China, is awash in speculative, excess crude, in addition to their own strategic reserves. And, of course, all this is happening in the context of a European war with serious risks of spreading to East Asia. Raiding the SPR to win the November election looks like bad policy and may even prove to be bad politics.
Source: Princeton Policy analysis of EIA STEO data
Meanwhile the Ukrainians continue to attack Russian oil refineries, reportedly causing a 4% loss of throughput and a 25% increase in Russian fuel prices. European Union fuel prices appear largely unaffected, although the Biden administration worries about retaliation against western energy infrastructure.
Source: European Commission, data through March 25
The dysfunction between Washington and Kyiv regarding policy towards the Russian oil business is essentially attributable to the misspecification of the Price Cap and Embargo. Were the Price Cap appropriately designed and implemented, Brent would effectively be capped at $75 / barrel through the US election in November. The excess inventories in Asia are all stored at logistics hubs and can easily be sold and delivered for consumption. The greater the OPEC+ production cuts, the faster excess crude inventories would flow into the market. Further, any increase in the price of oil would be beneficial to Ukraine, as a properly structured Price Cap mechanism would fully capture the value of the increased price. Brent at $100 / barrel would translate into an incremental $80 billion to Ukraine per year.
Finally, I would note the Kremlin's hostility to the US in attempting to raise oil prices to inflict damage on US consumers and tilt the US election. I would also bring attention to Business Insider's investigative piece on Havana Syndrome, which increasingly looks like attacks by Russian security services on US government employees and officials during peacetime. For those who think Russia is America's friend, I encourage you to read the article.
******
Oil Prices
Brent continues to show strength, closing on Monday at $87.75. Urals, Russian western crude oil export price, remains at $72, albeit with a lag in reporting due to the Easter holidays. Expect Urals to rise by $2 / barrel in the next few days.
If Brent crests and holds above $90, the Urals discount should shrink closer to $12 / barrel from the $14-15 discount seen in the last several weeks.
The Urals oil price remains the highest in the last nine years bar 2022.
Bottom line: Both Kyiv and the White House need to re-open the issue of the Price Cap and restructure it to Ukraine's and the Biden administration's advantage.
Go ahead, bomb some refineries
This week's news revolved around Ukraine's successful campaign against Russian oil refineries. Since the beginning of this year, Ukraine has hit more than ten major oil refineries and depots, some of them more than once. This appears to be causing disruptions inside Russia, and consternation at the White House, which has called on Kyiv to cease such attacks for fear of raising global oil prices. Kyiv has rejected such demands, declaring that Ukraine has "an absolute right to deplete the Russian army," according to the Daily Wrap.
Let's take a look at the numbers. Brent closed on Friday at $85.50, which is a bit higher than recently, but nothing special. ING Bank sees Brent at $87 for Q2, and given that Brent is almost there right now, oil would appear range-bound for the moment. Copper prices, which tend to covary with oil, also suggest Brent only marginally above current levels.
The risk of Ukrainian attacks on refineries is not on crude oil prices. Refinery attacks do not affect crude oil production. Rather, they constrain the ability to convert that crude oil into refined products like gasoline and diesel. If Russian refinery capacity is reduced, the Russians will simply export less refined product and more crude oil. For the moment, the Ukrainian strikes affect only a small portion of Russian throughput and are not influencing European fuel prices, as the graph from the European Commission below shows. If the crude is not refined in Russia, it will simply be exported as crude and refined elsewhere.
Source: European Commission
The graph above does, however, show that European pre-tax fuel prices are about 50% higher than before the war, owing principally to the Price Cap and Embargo.
The greater risk to oil prices are announced production cuts. Russia will cut its oil supply by almost half a million barrels per day in the second quarter of 2024, according to the Moscow Times. Russia's Deputy Prime Minister Alexander Novak said that Moscow plans to reduce its output by 350,000 barrels a day (bpd) in April, by 400,000 bpd in May and then 471,000 bpd in June. These cuts are reflected in the EIA's forecast for Russian production, which anticipates the Russian crude oil supply to decline by 530,000 bpd from January to June and bottoming at 10.3 mbpd before returning to previous levels in mid-2025.
Russian supply reductions are part of a larger OPEC+ production cut of 1 million bpd announced in late November. As oilprice.com opined, "Saudi Arabia and allies like Russia would prefer to see Donald Trump reelected, and they may therefore try to drive prices up ahead of the election. It will be harder for President Biden to win reelection if gasoline prices are skyrocketing ahead of the election."
The simple response to this is a restructuring of the Price Cap. The Price Cap has led to hoarding of crude oil stocks. If oil is selling below the market price -- and Russian oil is -- then traders will load up with as much as they can store, knowing they have profits locked in. We estimate global excess crude oil inventories (those above the level needed for the everyday operation of refineries) at 900 million barrels. This is only 200 million barrels below the pandemic peak, when analysts were expecting the entire oil sector to collapse. Put another way, excess crude inventories are at all but historic highs.
Source: Princeton Policy estimates using EIA STEO data
A restructuring of the Price Cap and Embargo would allow this oil to re-enter the market, as it would redirect the excess profits currently captured by Chinese and other oil traders to a G7 controlled entity. This would eliminate the incentive of traders to hoard inventories above normal levels, and they would consequently liquidate most of the excess crude. We can also estimate the pace of liquidation based upon the post-pandemic experience, which was 1.5 mbpd. As a rule of thumb, each incremental supply of 1 mbpd will reduce the price of oil by $10 / barrel. Thus, releasing excess crude inventories would be expected to knock $15 / barrel off the price of Brent for approximately 18 months, implying a Brent price around $70 / barrel. For purposes of comparison, the average price of Brent from the peak of excess pandemic inventories in May 2020 to the end of liquidation in Dec. 2021 was $57 / barrel, about $67 / barrel adjusting for the impact of lockdowns. Therefore, the expectation for $70 Brent and $65 WTI is plausible with a restructured Price Cap. Further, Urals would be pushed down to $55 / barrel, well off the Russian central bank's forecast of $71 / barrel for 2024. The Urals discount, which today stands at $14 / barrel and has averaged $12.50 over the last two months, might be expected to expand modestly to $15 / barrel, with all of that captured by the G7.
For the time being, Ukrainian strikes on Russian refineries appear to have no effect on diesel or gasoline prices in Europe, and the Biden administration should therefore yield to Kyiv's priorities in the matter. By contrast, announced production cuts by Russia and other OPEC+ members represent an appreciable risk of higher oil prices. The answer to that challenge is a much-needed and vastly overdue restructuring of the Price Cap. As the Biden administration has been slow on the uptake, the Ukrainians may ultimately be forced to take the matter into their own hands and sink a Russian oil tanker in the Black Sea. Now that would concentrate minds. The Price Cap would be restructured within days.
Open Borders; Black, Hispanic wages to $5; Easy win for MJ
President Biden and former President Trump both visited the US southwest border last week, each trying to claim the high ground with voters on border security. For now, President Trump's position is far superior to that of President Biden. Indeed, if policy stays as it is today, disaffected black and Hispanic voters will cost Biden the election. Under the circumstances, House Speaker Mike Johnson is well-placed to take an easy win.
Understanding Illegal Immigration
To understand illegal immigration, we need to consider the motivation for migrants to enter the US. Living conditions in Central America are the primary driver. Many there are very poor by American standards. Cross Catholic Outreach describes the situation in Guatemala:
In Guatemala, about one in four people earn less than $3.65 a day [$0.46 / hour], and nearly 60 percent of families fall below the poverty line. Many Guatemalan families are currently forced to take refuge in makeshift shelters built with inadequate materials such as mud, cane and tarp. Many also go without basic sanitation services. In fact, roughly one-third of the rural population does not have access to adequate latrines or toilets at home, a dangerous issue that contaminates local water and puts lives at risk.
Housing of the Rural Poor in Guatemala, Source: Guatemala Housing Alliance
The World Bank paints a similar picture of poverty in Honduras
Honduras remains one of the poorest and most unequal countries in the region. In 2020, as a result of the pandemic and Hurricanes Eta and Iota, the share of the population living under poverty (US$6.85 per person per day at 2017 PPP) reached 57.7 percent.
Rural, low income housing in Honduras; FPProjects 2020
Many Central Americans are destitute. Yet, as hard as it may be to believe, Central America is not exceptionally poor by global standards. Unskilled wages average $1.50 / hour in Guatemala and Honduras, but they are only $0.50 / hour in South Asia (India, Pakistan, Bangladesh) and $0.25 / hour in parts of sub-Saharan Africa. As impoverished as parts of Central America may seem, they are still middle class by the standards of much of the rest of the world. Even China is not much better, with a minimum wage of $2 / hour outside the large cities.
These realities drive poor Latin Americans and others to leave their home countries and migrate to the US, legally or illegally. Once such migrants are in the US, they will remain until they are indifferent between staying in the US or returning to the conditions shown above. That is, if borders are open, migrants will continue to come to the US en masse until their standard of living in the US, all things considered, is no better than in their home countries.
This has yet to occur, however, and for a good reason: border enforcement. Border enforcement has historically prevented most undocumented migrants from entering the United States. As a result, the demand in the US for undocumented migrant labor has generally exceeded its supply. Consequently, illegal immigrants have not encountered great difficulty in finding work at wages near those prevailing in the US, rather than those in their home country. This mirrors the dynamics of the illegal drugs trade. The great fortunes of the Colombian, and later Mexican, cartels were driven principally by the drug enforcement efforts of the DEA, Customs and Border Protection, and other agencies. Those who were able to smuggle drugs across the border enjoyed outsized profits because drug interdiction kept supply well below demand, leading to high prices and elevated profits. Illegal immigration is no different. It is border enforcement, and resulting high wages, which makes illegal entry so attractive.
In an Open Borders model, as currently practiced by the Biden administration, migrants can enter the country largely at will. Border Patrol and Customs are no longer limiting supply through enforcement. As a result, the equilibrium will not be the US unskilled wage, as it was prior to the Biden administration, but rather the migrants' home country wage. Over time, the living conditions of illegal immigrants (asylum seekers) and their competitors -- principally earlier waves of illegal immigrants and some low income blacks -- will tend to deteriorate, and do so in predictable ways.
Open Borders and Wage Levels
I have written frequently about the Relocation Wage, the wage necessary to induce a migrant to come to the US. This is the migrant's home wage, plus an adjustment for higher living costs in the US, and perhaps a premium to induce migrants to leave home. In Central America, the unskilled wage is $1.50 / hour. Add to that $3 / hour higher for higher living costs in the US, and migrants would need to earn $4.50 / hour at a minimum to come to the US. If we include a premium to induce relocation, unskilled migrants would move to or remain in the US for, say, $5 / hour, that is, about 30% of the effective minimum wage of $14-18 / hour in the US.
If Open Borders persists for an extended period of time, migrants will continue to arrive until those with whom they compete face either falling wages or a loss of employment. Of course, not everyone sees it this way. My friends at the CATO Institute, for example, might argue that migrants create their own employment, and indeed they do. The relevant question, however, is the maximum pace of absorption without disrupting either prevailing wages or employment levels. As my prior analysis showed, in a typical good year, the US can create around 2.5 million new jobs. By implication, the US is unlikely to be able to absorb much more than 1 - 1.5 million incremental, migrant workers annually.
At the same time, quite literally billions of people could be induced to move to the US even at wages much lower than those prevailing. For example, even if US unskilled wages were $5 / hour, unskilled Indian workers could triple their income by moving to the US, even after allowing for a higher cost of living here. That is, the pool of potential migrants vastly outnumbers -- by a factor of perhaps 1,000 to 1 -- the US ability to absorb them. The US would require centuries, and perhaps millennia, to absorb the potential pool of migrants without damaging its own labor markets.
Those most exposed are low wage blacks and Hispanics. A New York Post story illustrates the impact on undocumented Hispanic immigrants who arrived earlier:
Longtime migrant workers are disgruntled with new waves of arrivals to New York City who they say are undercutting them — claiming anyone hiring them should “get the f—k out of here”. “If you can get the work cheaper you are going to use those guys. You are not going to pay $200 when you can get [it for] $40. Anything you give them, they’ll take it."
Unskilled blacks are similarly affected. According to a 2007 study by the National Bureau of Economic Research, black employment is more sensitive to an immigration influx: “For white men, an immigration boost of 10 percent caused their employment rate to fall just 0.7 percentage points; for Black men, it fell a full 2.4 percentage points.” As Brian Mullins, cofounder of the Black American Voter Project, sees it today: "From construction to stores, even the guy washing the windows, it’s a migrant charging less than the black men.”
Nearly half of US blacks and Hispanics could be affected. A recent Oxfam study reports that 46% of Hispanic, and 47% of black, workers earn $15 / hour or less. For nearly half the minority electorate, unchecked immigration is a bread-and-butter issue.
Source: Oxfam: The Crisis of Low Wages in the US (2022)
Unemployment and Crime
The issues extend beyond hourly wages. The poor migrant will be in principle indifferent between earning $5 / hour with full employment, or $15 / hour with 67% unemployment, or some combination thereof. Therefore, open borders may, and likely will, lead to high levels of migrant unemployment which, from the migrant’s perspective, is still preferable to returning to their home countries. This portends the rise of the US equivalent of the French banlieues, blighted neighborhoods with low assimilation and youth unemployment rates in the 40-50% range.
Unemployed young men are prone to get into trouble, notably joining gangs and entering the drug trade. For example, the Miami Herald reports that a Venezuelan criminal gang that for the past few years has been extending its operations and causing havoc throughout Latin America has made an appearance in South Florida. Other migrants will turn to begging or scrounging. In New York, the mayor has instituted a curfew for migrants due to complaints about panhandling. The Chicago Tribune reported migrants were digging through trash bins in search of food.
Impact on Social Programs
To most Americans, migrant poverty, homelessness and unemployment will seem a terrible and intolerable social ill. This will lead to initiatives to improve the lots of newly arrived migrants. Unfortunately, accommodating migrants will cannibalize social services and welfare programs targeting low income Americans. For example, the principal of a high school in New York City had to defend housing migrants in school as students went remote. Indeed, New York City data shows over 116,000 migrants have flocked to the Big Apple since last spring and most are making ends meet working in the illegal underground economy — many while still living rent-free at taxpayer-funded hotels and shelters.
A Growing Backlash
All this is causing a backlash in the black community. As Chicago Magazine notes in What about Us? (July 2023):
In May, when then-mayor Lori Lightfoot announced plans to house 250 Venezuelan migrants in the old South Shore High School, she ignited a nativist backlash that sounded like something from a Donald Trump rally. “It is a slap in the face that we as citizens of the United States of America do not have the resources and support, but you’re gonna bring people that are not citizens here in our buildings that we pay taxes for that you took away from us,” South Shore resident Natasha Dunn said outside a public meeting at the school. Inside, a protester waved a “Build the Wall 2024” placard.
Source: Townhall
When the black community feels it has to brandish 'Build the Wall' posters, the Biden administration can assume it is in trouble. And that's what the polls show. Support for Democrats is crashing, with 'net lean Democrat' in the last two years down from 62 to 47 percent among blacks and a shocking 31 to 12 percent among Hispanics, according to Gallup surveys. Open Borders is not winning the friends the Democrats had expected.
Political Implications
Open borders has opened a conservative economic appeal to minority voters. Consider this hypothetical Trump pitch:
"Flow Joe" Biden. He's just going to flow those illegal immigrants across the border, millions every year. And they're coming for your jobs. We'll have more illegal immigrants than new jobs this year, and that means $5 / hour migrants are coming for your work. Three million of them. And if Joe's re-elected, they'll just keep coming year after year or until you're earning as much as some poor Guatemalan migrant. The rich Democratic elites, they'll have all the cheap labor they want. House cleaners, landscapers, and labor for construction and factories. Cheap, cheap, cheap. And if you're a low wage black or Hispanic, you'll end up being that cheap labor. Can you afford to re-elect Joe Biden? Can you take Open Borders for another four years? Because $5 / hour is what you're going to get if you vote for Joe Biden.
This appeal is not going to fall on deaf ears, and it is one of the principal reasons that Biden's support among blacks and Hispanics is cratering.
Source: Financial Times
Joe Biden and the Democrats have little option but to close the border, but owing to the requirements of their own political base, would like to blame it on the Republicans. This in turn constitutes a huge opening and prospects of an easy win for House Speaker Mike Johnson.
As I have stated before, the Republicans' demands should come down to a single requirement: asylum requests in the US should only be allowed to those otherwise legally present in the country. We anticipate this one change would reduce border encounters by 70% compared to our forecast for the back half of the year, to under 70,000 / month. This is still a high number, but a vast improvement compared to expectations.
Such an approach would allow Mike Johnson to take the podium and declare the Republican position in a single, simple soundbite: no asylum to those in the US without legal presence . This would enjoy the support of the majority of Americans who clearly appreciate that the surge in illegal immigration is driven by the egregious abuse of US asylum law. Further, it would position the Republicans as a constructive force in American politics, not the purveyors of clown show dysfunction and dictatorship that they project today.
Finally, it would also clear the path to freeing funding for Ukraine, whether by loan or grant or some combination.
The net result would be at least a partial recovery of the Republicans as standing for law and order, both domestically and internationally. The Democrats have been far too soft on domestic crime and disorder; the Republicans are bizarrely attracted to a foreign autocrat waging war on our allies and firmly committed to the destruction of the United States. Closing the asylum loophole and standing up for our allies would restore a necessary balance, promoting order both at home and abroad.
Illegal Immigration Outlook 2024
Illegal immigration is top of the US political agenda heading into the election, and of course, frames the possibilities of Ukraine funding. In this post, we look at the outlook for 2024.
We forecast US southwest border encounters by Customs and Border Patrol at 2.7 million for FY 2024, based on the last three months of data, adjusted seasonally. Apprehensions look to come in just a hair above 2023 levels. Inadmissibles, those presenting at official crossing points without appropriate documentation, are slated to rise by almost 200,000, largely due to the monthly rise over the last year, but essentially at the same pace as seen in the last few months. Thus, 2024 is forecast to see a new all-time record for encounters, eclipsing the pre-Biden records set under the Reagan and Clinton administrations by more than one million. It is also 400,000 higher than the quantities proposed in the much-maligned Border Security Act promulgated last month.
Source: US Customs and Border Protection, Princeton Policy analysis and forecast
Border encounters do not, of course, directly determine the number of undocumented migrants gaining entry into the US interior. Historically, most of those arrested at the border were deported. Further, not all those crossing the border are detected or detained, with these collectively known as 'gotaways'. To appreciate the societal impact, the change in the undocumented population must be separately estimated. The 'go-to' source for such numbers has been the Pew Research Center, which has estimated the undocumented population every few years. Pew's estimates are not without their critics, including me, but are still the most widely accepted. By Pew's count, the undocumented population of the US rose by an average of 256,000 per year from 1994 to 2020. This number is skewed by the effects of the Great Recession, which actually saw the undocumented population fall. If we exclude the 2008-2020 period, Pew's analysis suggests the undocumented population rose by 550,000 per year, which we might consider the normalized value for assessing undocumented entry during the Biden administration.
Source: Pew Research Center; US House of Representatives Committee on the Judiciary and Subcommittee on Immigration Integrity, Security, and Enforcement (Oct. 2023): Princeton Policy analysis
As the graph above shows, undocumented entry has exploded under the Biden administration's Open Borders policy, rising from an estimated 1.1 million in 2021 to our forecast of 3.2 million for 2024.
As these numbers are likely to draw protest from various DC think tanks, allow a brief digression into methodology. Our forecast is based upon statistics from Customs and Border Protection and numbers contained in the House Judiciary Committee's Oct. 2023 report, "The Biden Border Crisis" (well worth reading for the outrage alone). The House report, prepared under a Republican majority, is clearly hostile to the Biden administration. Nevertheless, the figures presented appear largely accurate and therefore suitable for our analysis and forecast.
'Undocumented entry', as defined on the graph above, includes those apprehended at the southwest border but released into the interior, either directly by Border Patrol or later by ICE or HHS. It also includes CBP One paroles and categorical paroles for Cubans, Haitians, Nicaraguans, and Venezuelans. And finally, the estimate includes 'gotaways' as given in the House report. Our 2024 forecast is based on these numbers adjusted for anticipated border encounters.
The change in the undocumented population and undocumented entry are not quite the same thing. The sources of data and the types of estimating vary. For example, undocumented entries do not include undocumented departures, which would be captured implicitly by Pew's undocumented population estimates. Nevertheless, the differences are so stark that, regardless of the methodology used, undocumented entry during the Biden administration can be considered categorically different from illegal immigration and border enforcement under any prior president, Republican or Democrat. Moreover, the graph highlights the difference between leaky border enforcement and a de facto Open Borders policy as practiced currently. Open Borders permits Illegal immigration effectively an order of magnitude greater than under the customary US border enforcement regime. It is therefore no surprise that Republicans are making such fuss over the matter.
To an extent, President Biden has been lucky so far. Job growth has been simply extraordinary, the best since at least 1939. The first three years of the Biden administration saw the addition of nearly 14 million non-farm jobs. This easily eclipses the closest comparable, the Carter years of 1976-1978, which saw growth of 10 million jobs. Of course, the principal driver of recent employment additions has been the recovery from the pandemic, during which the US lost more than 8 million jobs. Notwithstanding, jobs are beginning to catch up with long-term trends, and as a result, 2024 promises to be a solid, but not exceptional, year for employment growth.
Source: FRED (PAYEMS); Princeton Policy trend projections
A historically strong job market largely negated the impacts of unchecked immigration in 2021 and 2022. Although undocumented entry was high, job growth was even higher, and consequently, the US labor market absorbed arriving migrants without material disruption. This began to change in 2023, with our estimate of undocumented migrant arrivals reaching 80% of total job growth. Resentment from Hispanics, notably from earlier-arrived, undocumented immigrants, and from blacks began to rise.
Sources: FRED (PAYEMS); Pew Reseach Center; House Judiciary Committee (Oct. 2023); Princeton Policy analysis
We forecast that undocumented entry will exceed US job growth in 2024. Thus, the resentments seen last year will likely become exacerbated as the US economy is unable to fully absorb arriving migrants. For President Biden and Democrats, this represents a huge risk. The path to defeat in November is not principally through disaffected independents and moderate Republicans, but rather through low-wage blacks and Hispanics who will turn to Trump in fear that another four years of Open Borders will gut their wages. As I explain in my next post, these fears are not misplaced.
Rigs and Spreads Feb. 23: More of the same
Rig and spread counts are largely unchanged over the last several months. Rig counts are materially unchanged since September, and spread counts are at the level of two years ago
Rig counts
Total oil rig counts: +6 to 503
Horizontal oil rig counts: +2 to 452
Frac spreads rose last week, +6 to 270, now fully recovered from the winter trough
DUC inventory continues to roll off, roughly at the pace of one DUC per day
DUC inventory for January stood at 12.3 weeks of completions, the lowest in a decade, likely attributable to adverse January weather; February numbers should be more typical of recent times
Both the EIA’s monthly Drilling Productivity Report (DPR) and Short-Term Energy Outlook (STEO) tell a similar story.
The EIA has been calling for a local US crude and condensate production peak since late summer
Notwithstanding, production figures are revised up subsequently, with the peak pushed farther to the right and currently pegged for late last year.
On an eyeball basis, it appears likely that upward revisions will continue through the middle of the year and perhaps into the autumn, but increasingly within a framework of declining production. That is, at some point in H1 2024, the EIA’s peak production number is likely to hold, even in the face of subsequent upward revisions.
Around Q4, upward revisions should cease, and US production will begin to ease down. A price rally would seem to be lurking around that window, depending in part on events in Asia.
The news from China is negative almost without exception, and I think the Chinese economy will continue to struggle.
On paper, China becomes a democracy in the next two years.
Of course, China may also continue to withdraw from the global economy, as it has traditionally during its long history. This is not easy to do with that country’s level of indebtedness, the sophistication of its economy and much of its population, and declining demographics.
Finally, Xi could try the ‘Galtieri Gambit’, launching a war to take over a small island neighbor with the hopes of propping up the autocrat’s popularity, per the Falklands War precedent.
Let’s hope for democracy.
The Republicans lose Avdiivka
The Ukrainians were forced to retreat from the stronghold of Avdiivka, which they had held against the Russians since the start of the war in 2014. The principal cause of the retreat was a "shortage of ammunition because of declining Western military assistance", the New York Times reported. That is, the Ukrainians were forced from Avdiivka due to a lack of US funding directly caused by the House Republicans.
The Russian advances are unlikely to stop there, as ammunition shortages are endemic up and down the front, again, courtesy of the House Republicans. Thus, the House Republicans can chalk up a defeat of US interests and policy to Putin's Russia, despite a US economy fourteen times larger and a population twice as big. Mike Johnson's speakership has brought us to this point: a historic US defeat at the hands of Russia, with more to come.
And where is Johnson? He called an early vacation for the House. As the conservative Washington Examiner put it:
Lawmakers left the Capitol on Thursday afternoon without making progress on several pieces of legislation the House initially scheduled to consider this week. The lower chamber is not scheduled to return until Feb. 28, just days before the federal government is set to enter a partial shutdown on March 1.
Johnson's speakership is rapidly disintegrating, as Rep. Thomas Massie (R-Ky.), posting on X (Twitter), noted:
Getting rid of Speaker McCarthy has officially turned into an unmitigated disaster. All work on separate spending bills has ceased. Spending reductions have been traded for spending increases.
Warrantless spying has been temporarily extended. Our majority has shrunk.
The speakership is a difficult position at the best of times. It is the sausage machine of government policy, where high-minded principles are ground up and converted into legislation that can command a majority vote. The role involves all of persuasion, threats, bluffs, promises, trades and trickery. While representatives like Matt Gaetz (R, FL) can afford to throw grenades over the parapets, the Speaker has to make the machinery of government work. With a razor thin majority and a fractious conference, Mike Johnson is facing a Herculean task. He looks increasingly overwhelmed.
All of this is terrible for Ukraine. And it will ultimately prove terrible for the Republicans. They will now have to take the blame not only for the anarchy in the House, but also for Russian victories in Ukraine.
As it stands, Republicans are not weak on national security, they are anti-national security. Let's see how the voters like that come November.
Two Conditions for Ukraine Funding
If the Republicans want to look a bit more politic, here are two conditions to tie to Ukraine funding.
Regarding asylum and border security:
Asylum
Claims for asylum can only be made
1. By those who have lawfully entered and remain in the United States
2. At any US embassy or consulate abroad
3. Via the CBPOne app outside the United States
That's it. It's easy to explain and does not require a 320 page bill or a week of analyst time to digest. The public will understand what it means, and it is fundamentally reasonable. It will not stop illegal immigration in its totality, but should reduce undocumented entry to more customary levels of border chaos.
I might add another condition:
The Ukraine Compensation Fund
The President shall endeavor to redirect the Urals Discount to a G7 Entity to be used for funding military and economic assistance to Ukraine.
If the point is to reduce the fiscal burden of the war on the US, then the most tangible source of funds is the Urals discount, the difference between Brent and Urals, Russia's western oil export price. That's worth about $34 bn / year based on today's oil prices, and could be worth twice that next year if oil fundamentals develop as many in the industry expect. Should this be successfully implemented, our analysis suggests the Russians will have effectively lost the war.
The Border Act bodes ill for Ukraine
Ukrainians may be wondering how in the world the survival of their country has come to depend on US border legislation. It's an ugly story, and the outcome bodes poorly for Ukraine.
Illegal immigration has been a problem in the US since the passing of Hart-Celler Act of 1965, effectively a prohibition on the use of seasonal migrant labor in the fields of California. Historically, Mexicans came north to pick California's crops and returned home after the season. The Hart-Celler Act prohibited this flow, making it harder for Mexicans to enter the country and thereby giving them an incentive to stay in the US permanently once they had crossed the border. This dynamic really took off in the 1970s and reached crisis proportions in the early 1980s.
The proposed solution was a broad amnesty for illegal immigrants in return for enhanced border enforcement, signed into law by President Reagan in 1986. The amnesty went through, but undocumented entry stayed high, indeed, it reached record levels, just as black market theory would suggest. Republicans felt that they had been duped -- they had -- and they have not forgotten it to this day. Any proposed border legislation is viewed through the lens of this 1980s debacle.
The magnitude of illegal entry into the US is enormous. Only twice before the Biden administration did border apprehensions -- a measure of illegal entry attempts -- exceed 1.6 million. By contrast, apprehensions averaged 2.1 million in the first three years of the current administration. Moreover, apprehensions historically led to expulsions under prior presidents. Today, apprehended migrants can simply claim asylum and be released into the US interior in most cases. The Senate's proposed Border Act of 2024 does not crack down on such illegal entry until a minimum of 5,000 daily apprehensions are reached, equal to more than 1.8 million apprehensions per year. This again would be a record for any year prior to the Biden administration.
Further, migrants without proper paperwork at official crossing points were historically turned away and hence deemed 'inadmissible'. Today, a migrant can walk up to passport control, claim asylum and be allowed into the country, even without any papers at all. This has led to a surge of such 'inadmissibles' -- today, really 'admissibles' -- to 500,000 in 2023, with a minimum of 511,000 proposed in the Senate's bill. Thus, the Biden administration is proposing undocumented entry of 2.3 million per year, 0.7 million higher than the pre-Biden record.
This is a large number in terms of overall demographics in the US. The UN estimates average annual US population growth at 1.5 million for the 2021-2024 period. By implication, undocumented admissions to the US will constitute more than total US population growth, around 50% more in fact.
The President has the authority today to radically reduce undocumented entries. While they would not be fully eliminated, apprehensions would fall to 1 million or even less. Nevertheless, the President wants these numbers high, in part to be 'nice' to poor migrants and in part because the administration hopes to convert them to Democratic voters over time. Open borders is therefore the de facto policy of the Biden administration.
Given this situation, House Republicans predictably rejected the Senate proposal out of hand.
But how they did it was a disaster.
The Act's Senate sponsor, Republican Senator James Lankford, was clearly played. The Democrats dragged the process out, making concession after concession, but never removing the discretionary enforcement rights of Secretary Mayorkas or the President. Without hard commitments, Democrats were well aware that the House Republicans would reject the bill outright.
This might not have been the end of the world had House Speaker Mike Johnson (R, LA) not committed two rookie mistakes. By declaring the Senate bill 'dead on arrival', Johnson assumed responsibility for its failure. He instead should have stated that the bill had many merits, but would require specific adjustments to bring it closer to HR 2, the border bill passed by the House last May. If the Senate's bipartisan coalition would incorporate House requirements, the House would be prepared to pass a compromise bill. This would have shifted the burden back to the Democrats and, more importantly, bought some time.
The analyst community required a few days to assess the proposal for the disaster it appears to be and lend support to the Republican position. By committing too early, Speaker Johnson lost the news cycle and took the blame in the press. This led to near civil war in the Republican Party, with Senators "close to shouting at each other as tempers flared during the contentious discussion," as The Hill described it.
Meanwhile, the House Speaker has tied Ukraine funding to border legislation. The argument for withholding funding, other than a surreal faith in President Putin as the friend of MAGA, comes down to saving that $60 billion slated for Ukraine. And this will sound terrific until Ukraine starts losing, as appears to be the case with Andivka now. If the issue is framed as fiscal discipline, that's one thing. But when it will be framed as the US losing to Russia -- and make no mistake, that is how it will be depicted by the Kremlin, the Chinese and a host of other unsavory countries -- that $60 bn will have looked dirt cheap. By rejecting the border bill and thereby depriving Ukraine of funding, Mike Johnson and the Republicans have assumed responsibility for everything that could go wrong in Ukraine. If Ukraine falls, the Republicans will own it. Mike Johnson will own it.
The reality is this: If the Republicans vote for $60 bn in aid for Ukraine, some in the MAGA camp will grumble, but no one is going to vote for the Democrats because of it. On the other hand, if the Republicans lose to Russia -- and that is how it will play in the media and public opinion -- a great many Americans will not vote again for the Republican Party for a long time, and that will be Mike Johnson's legacy. Mike Johnson is again setting up the Republican Party for the Democrats' ultimate sucker punch.
Paradoxically, the President and the Speaker need each other. The administration's open borders policy is undermining the Democrats' political support with blacks and Hispanics. Meanwhile, the Republicans absolutely, positively do not want to be blamed for losing to Russia. Odd as it may seem, the Speaker and the President both need the other side to have someone to blame for policies which are not only necessary, but politically expedient. The President needs the appearance of coercion by the Republicans to avoid blame for a necessary tightening at the border, and Speaker Johnson needs to concede Ukraine funding to avoid assuming all blame for losing Ukraine.
None of this is simple, and perhaps none of it is even possible. For that reason, Ukraine's situation is looking increasingly dire. As matters stand, however, the President is putting re-election at risk by unleashing nearly 10 million undocumented migrants into the US during his first term. And Mike Johnson thinks toeing a Trumpian line is the path to success. He would be well advised to remember that Washington is littered with the bodies of Republicans who tied their reputations to the former president.
Minutes of US Labor to Purchase a Gallon of Gasoline
US Crude and Condensate Supply Outlook
Price Cap, Ruble: Rebound of the Urals, Russia Coping
Oil Prices
The oil price scene has been relatively uneventful in the last two months, with Brent loitering in the high-$70s to the low-$80s and dropping $6 last week alone to a tepid $77 / barrel on Friday.
Urals, Russia's western oil export price, has similarly been hanging around the Price Cap limit since early December, averaging $59.50 until the past week. Even as Brent was sliding, Urals has spiked up the past ten days, gaining $7 / barrel to close at just under $68 / barrel on Friday.
Accordingly, the Urals discount - the difference between the Urals price and Brent -- has narrowed, closing at $8.72 on Friday and averaging $13.19 / barrel for the week. This average is actually close to our forecast value of $12.62. Notwithstanding, the discount is probably understated as changes in Brent tend to be reflected only with a lag in Urals, and the drop in Brent will only be captured in the Urals price this coming week.
Still, it looks like the Urals discount is on the decline once again. This is not unexpected, as this sort of volatility is typical of black markets. The US stepped up Price Cap enforcement in November, and the discount widened as a result. A greater discount increases profits, and this induces the introduction of new players or new smuggling methods to the Russian oil trade. The resulting increase in demand then closes the discount once again.
This is the same dynamic which we see with illicit drug prices. A round of enforcement creates scarcity in the narcotics supply, which raises prices and profits, and stimulates innovation in smuggling practices. This in turn causes the Whac-a-Mole syndrome which we see in not only Russian oil smuggling, but also in drug smuggling and illegal immigration, the latter being the smuggling of illicit labor over the US southwest border. Because enforcement increases available profit margins to intermediaries like drug cartels or UAE shipping companies, enhanced enforcement is quite literally self-defeating, and a key reason why prohibitions are to be avoided as public policy. Every time one channel of smuggling is blocked, another appears somewhere else, with the authorities constantly chasing the smugglers' ever-changing tactics, just like the children below trying to whack the moles as they pop up.
The Urals price is not particularly high by recent standards, but is in fact the highest since 2015, excluding only the surge of 2022 at the start of the war.
Ruble
Like Brent, the ruble has been largely range-bound since November, trading within a few points of 90 ruble / USD.
Russian money supply growth, as measured by M2, has been ebbing according to the statistics of the Russian central bank. Annual money supply growth in Russia reached 24% in 2022, but only 19% at the close of 2023. The Russian money supply from 2015 to 2021 grew by 10% annually on average. Thus, Russian M2 growth has substantially exceeded historical norms in the past two years, with the implication that accommodative monetary policy has been supporting the Russian economy, and by extension Russia's war effort, by the equivalent of $114 bn in 2022 and $71 bn in 2023. Russia's elevated interest rates, 16% from December, appear to be having the desired effect of reducing inflationary pressures. Moscow appears to be successfully adjusting policies, notably fiscal policies, to deal with the costs of the war.
Congressional Salaries should be $294,000
Sen. Elizabeth Warren (D, MA) has called for an increase in Congressional salaries. But what's the right number, and even more importantly, the right structure? Pay structure matters, because it is the key tool for ensuring good governance, including, for example, 'draining the swamp', addressing corruption in Ukraine, and capturing Russia's governance in the post-conflict world.
Many forms of analysis commonplace in the corporate world are virtually unknown in the US government and DC think tank circles, and this includes the use of comparables. In the private sector, when we try to establish the price of a good lacking a market -- Congressional salaries, for example -- we try to find a proxy. And, in fact, we have one: the starting salaries of first year associates in New York. Why this? Most legislators are lawyers by trade, and we -- or at least I -- would hope that the public would prefer the best and the brightest to become members of Congress. First year law associates in New York are the best and brightest of their year, typically from Ivy League universities, and their salaries are tied to the market for premium legal services in the US. Therefore, if we believe we would like to recruit top-line legal professionals to serve in Congress, then first year associate salaries are a plausible comparable. Helpfully, such salaries have been published for more than fifty years.
As the graph above shows, Congressional pay in the 1960s was twice the compensation of first year legal associates in New York. By the mid-80s, however, legal salaries were catching up to Congressional pay, with Congressmen earning around 1.2x that of a first year associate. After 2000, first year lawyers in Manhattan were earning as much as twenty-year Congressional veterans. Since Congressional salaries were frozen in 2009, the comparison has yearly deteriorated such that today a 65 year old Senator will earn only 71% of the pay of a first year New York lawyer with effectively no work experience. In fact, the Majority and Minority leaders in the House and Senate earn $52,000 (21%) less, and the Speaker of the House earns $21,000 (9%) less, than a first year lawyer in New York. This is frankly pathetic.
I would argue that a Senator should make considerably more than a first year lawyer, perhaps twice as much, but the political equilibrium seems to fall considerably lower. Even so, a Congressman should make at least 20% more than a first year lawyer, about the same ratio as in the 1980s. If we apply that metric, Congressional salaries should be set at $294,000 for 2024, a 70% increase over the current pay level.
Structure matters even more. The MAGA crowd wants to drain the swamp by changing personnel. But that's not how the professionals do it. If you want to change behavior, you change the way people are paid, specifically by tying pay to performance.
I have consulted for both the private and public sectors, and the differences are stark. In the private sector, it's about delivering a product that customers value more than it costs to produce. Efficiency and effectiveness are essential. By contrast, money is not currency in politics. Popularity and electability are. Cost/benefit analysis may motivate economists and the think tank world, but I have never seen it used in producing legislation. Instead, policy in the real world is about catering to the preconceptions of constituents, toeing the party line, and adherence to pre-cooked ideological positions. Politicians often talk about fraud and waste, and some governments are indeed run by criminals and incompetents. (Corruption is the handmaiden of incompetence, in my experience.) In general, however, I have found national level bureaucrats and staffers in DC to be well-educated, well-meaning and competent. I consider many of them to be kindred spirits and friends. The problem runs deeper. Monies are typically allocated in the political process with little to no regard for effectiveness or efficiency, and implementation is often painfully slow and bureaucratic. This may not matter when the government is small, but when the national budget is $6 trillion / year, as ours is, the difference between slightly better and slightly worse governance is easily $1 trillion / year. That's a lot of money.
Tying pay to performance is a means to inject some discipline into the system, to motivate lawmakers to use taxpayer funds carefully. I will not belabor the mechanics of such a program here. Such a program would, however, have the effect of tempering political rhetoric in Congress and encouraging cross-aisle cooperation. It's one thing to bad mouth your opponents when it's costless. But when your bonus depends on using money wisely, well, people find a way to cooperate. If you're a burn-it-to-the-ground MAGA Republican, the most revolutionary thing you could do is introduce a performance-based bonus. Democrats might have to go along with it. After all, they want a pay raise, too.
Oil Production Growth: Russia > USA
Our regular round-up of Russian oil production, prices and Price Cap enforcement. I would also highlight coverage of our previous post in the Washington Examiner, Biden ignoring Pentagon, defense spending at pre-World War II levels.
Russian and Global Oil Markets
The EIA's monthly Short-Term Energy Outlook, issued this past Tuesday, reports Russian oil production rising to 10.76 mbpd in December, up a bit over the prior month. This is an impressive 200,000 bpd higher than the EIA expected just three months ago and the fourth consecutive monthly rise in Russian oil production.
The EIA has meanwhile updated its annual forecast for US oil production. In essence, this sees US production materially flat from September 2023 through the first half of 2025.
In fact, Russian oil production growth has marginally exceeded that of the US since August.
Flat US oil supply would ordinarily be bad news, as US shale oil production provided the discipline on oil prices for the last decade. However, two factors may mitigate the risk of an oil price surge. The first of these is weak anticipated demand growth from China. If all were well, we might expect annual oil demand growth of 3-5% or 0.5-0.7 million barrels per day / year (mbpd / year) in China. Nevertheless, the EIA anticipates growth of less than half this level, indeed, only 0.25 mbpd or 1.5% in 2025. This is consistent with the generally glum outlook for China.
Finally, OPEC is carrying surplus production capacity of approximately 2 mbpd over normal levels, and OPEC would ordinarily seek to deploy these reserves if the opportunity arose. Like weak Chinese demand, surplus capacity could act to suppress oil prices, which is good for Ukraine, as well as for the US and western Europe in aggregate.
Therefore, although plateauing US oil production would ordinarily be bullish for oil prices and negative for Ukraine, a poor outlook for China and ample OPEC production reserves suggest that oil prices could remain range-bound in 2024, and possibly beyond. On the whole, this appears positive for Ukraine.
Oil Prices
Brent closed on Friday at $78, largely in this range now for the last six weeks. A neutral price for Brent might be $82-87 / barrel, thus Brent would appear modestly below normal at present. Urals was similarly weak, closing Friday at $59, below the Cap limit for all of January to date.
Interestingly, the Urals discount, the difference between Russia's western oil export price and Brent, remains comparatively wide, averaging nearly $20 for the week. This is $6 greater than our forecast and suggestive of at least partial success in sanctions enforcement. Someone over at OFAC deserves a pat on the back for their sanctions work.
Ruble
The ruble appreciated marginally against the dollar this week, closing at 88 ruble / USD. This is largely unchanged in the last two months and contradicts recurring claims of a collapsing ruble.
Overall, oil prices remain favorable for Ukraine. We now need Congress to step up with some serious funding, notwithstanding fairly disastrous deficit numbers. Moreover, the Biden administration needs to refocus away from trying to seize Russian assets -- which are pretty well ring-fenced -- and instead restructure the Price Cap to capture the Urals discount and redirect this to Kyiv.
US defense spending below pre-war level, at historic lows
Reading the press, one might think US defense spending has reached astronomical heights. Take, for example, Barrons' latest piece on the topic, US Congress Passes Huge $886 Bn Defense Budget For 2024. One would think that the US is all-in for some cataclysmic battle.
Not even close.
Under the Biden administration, defense spending as a share of GDP has fallen to its lowest level since before World War II. The Fiscal Year 2024 Defense budget does raise spending as a share of GDP marginally, but to a level essentially tied for the lowest in the last 84 years with the 'peace dividend' during the Clinton administration. In fact, defense spending in 2024 will be a smaller share of GDP than it was before the Ukraine war began.
The comparison with earlier conflicts is even more stark.
During the Korean War (1950-1953), the US spent at peak 16% of GDP on defense, more than four times the current share.
During the latter stages of the Vietnam war, defense consumed 10% of GDP, three times the current level.
And during the Reagan administration, when the US was spending the Soviet Union into bankruptcy, defense outlays represented 7.6% of GDP, more than twice the current share.
Indeed, if we took the Ukraine war as seriously as the Korean war, then we would be willing to spend more than $4.4 trillion on defense, comfortably twice Russia's entire GDP.
Instead, US defense spending eroded to 3.6% of GDP in 2023 from a lowly 4.0% before the Ukraine war. The new defense budget raises spending marginally, to 3.8% of GDP, but remains the lowest share in the last 84 years, barring only the prior two years of the Biden administration.
Thus, given the perilous state of global security, defense spending stands at irresponsibly low levels and represents more mockery of, than commitment to, national security. To suggest that the US cannot afford to fund the war against Russia, that somehow we are tapped out and compelled to take a loss in Ukraine, is flatly untrue. Defense has been pathetically neglected under the Biden administration.
If I view the numbers as an analyst, a bump in defense spending to 4.6% of GDP looks warranted under the circumstances. This would represent an additional $225 bn in 2024 to prosecute the Ukraine war, among others.
Putin cannot match that. Russia's pre-war military budget was a mere $66 bn, rising to $140 bn for 2024, representing 35% of total government spending in Russia this year. Putin's discretionary war in Ukraine, one which he could stop tomorrow without harm to Russia, is squeezing out non-military programs, including social spending. The Russian public will not be happy.
This much is clear: The US is strong. Our military potential is not exhausted, it's untapped. It is our political potential which is exhausted. There is a lack of seriousness in Washington. The Biden administration appears to be playing at war rather than knuckling down and winning it. Meanwhile, Congressional Republicans seem ready to abandon national security. Behind all this is the notion that projecting weakness and indecision will translate into perceptions of strength and political popularity. If only our politicians show sufficient hesitation, lack of conviction and subservience to Moscow, US voters will love them. It's a model of leadership through capitulation.
President Reagan spent twice as much on defense as a share of GDP as we are, and Reagan did that at a time when we were not involved in a major conflict with the Soviet Union. This policy bankrupted the Soviet Union and represents one of the crowning achievements of the Reagan administration. We can easily do that again. A 1984 CIA analysis estimated the US economy at the time to be twice the size of the Soviet Union's. Today, the US economy is 5-14 times the size of Russia's, depending on the metric used. If the US is serious, Russia cannot keep pace, and Putin knows it.
It comes down to intent. President Biden may not be willing to lead on this. But House Speaker Mike Johnson can. If he says, "The US intends to prevail in Ukraine," and backs it up with some serious money, then we'll know where to find real leadership in Washington.
Wars: Korea vs. Ukraine
Rigs and Spreads Jan. 5: Steady rigs and imploding spreads
The rig and spread counts are seeing both regime change and seasonal variation
Horizontal oil rig counts appear to have stabilized in the mid 450s, essentially unchanged in the last two months.
This represents a new regime in the shale patch, as counts had been falling steadily throughout 2023
Frac spreads have rolled off heavily over the last four weeks, down 32 since early December.
Most of this can be attributed to seasonal factors, but the effect has been to stem the erosion in the DUC inventory witnessed over the last several years.
On seasonal trends, spread counts may be expected to recover over the next several weeks, leading to a renewed erosion in DUC inventories.
We continue to see a disparity between the EIA and media reports with respect to production growth.
The media frequently refers to surging US oil production, and that is certainly true considering 2023 as a whole.
However, the EIA sees US shale oil production peaking in October 2023, with modest declines to be expected over the next several months.
*****
Rig counts
Total oil rig counts: +1 to 501
Horizontal oil rig counts: +1 to 457
The Permian horizontal oil rig count: +3
The US horizontal oil rig count is rising at a pace of +0.5 / week
Frac spreads fell, -4 to 236, the lowest level in more than two years
DUC inventory, as measured in days of turnover, rose to 16.1 weeks on seasonal factors
Based on last year’s precedent, expect the spread count to recover and inventory to fall back towards 14 weeks