Latest / Energy Economics with Fexingo: Oil Prices, Renewables, and the Cost of Power / How Weather Shocks Are Driving Oil Above 90 Dollars
Transcript
- Lucas: Brent crude breached $90 a barrel over the weekend. That's the first time we've seen that level since — what, early 2025? Luna: Yeah, about eighteen months. And it's not just Brent. WTI's up more than 5 percent in the last five trading days, sitting around $83.75. Lucas: So the obvious question: what's driving this? The headlines point to Middle East tensions — U.S.-Iran rhetoric heating up again. But if you look at the price action, there's something else going on. Luna: Weather. Lucas: Exactly. CNBC ran a piece this morning called 'From Super El Niño to Europe's extreme heatwave: How this year's weather shocks are rattling commodity markets.' And that's actually the more interesting story. Because the geopolitical risk premium has been in oil for weeks. But the move from $85 to $90 — that happened in the last five days, and it correlates with a massive heatwave across southern Europe and a strengthening El Niño in the Pacific. Luna: So you're saying weather is the catalyst, not Iran. Lucas: I think it's the trigger. The geopolitical backdrop provides the floor — everyone knows the Strait of Hormuz is riskier than it was a year ago. But the spark was the European heatwave driving up cooling demand — more air conditioning, more natural gas burn for power, more diesel for backup generators. At the same time, El Niño is threatening to disrupt agricultural commodities and could affect oil production in parts of the Gulf of Mexico if hurricane season gets active. Luna: And the data backs that up. The latest CPI print from June showed headline inflation easing to — well, the index dipped slightly. But core CPI is still sticky. And the 10-year breakeven inflation rate — which is basically the market's expectation for future inflation — ticked up to 2.24 percent last week. Lucas: That's the highest since April. So the bond market is saying: this oil move is not a blip. It's feeding into inflation expectations. And if oil stays above $90, that could complicate the Fed's path to rate cuts. Luna: Right. Because the last mile of inflation — getting from 3 percent to 2 percent — is sensitive to energy prices. We saw that in 2022. Lucas: Exactly. But here's the twist: natural gas isn't joining the rally. Henry Hub is at $2.88, down 1.4 percent on the week. So we've got oil surging and gas falling. That's unusual. Luna: Why the disconnect? Lucas: Two reasons. First, European gas storage is nearly full — they hit 90 percent capacity ahead of schedule because of a mild winter. So the heatwave is boosting spot power prices, but it's not creating a supply crunch. Second, U.S. natural gas production has been resilient. The Permian Basin is still pumping associated gas, and we haven't had the production cuts that some analysts expected. Luna: So the oil rally is more about demand-side shock from weather, while gas is benched by ample supply. Lucas: Exactly. And that has implications for the energy equity market. Look at the XLE — the energy sector ETF — up 1.7 percent in the last five days. But within that, the divergence is stark. ExxonMobil up 2 percent, Chevron up 2.8 percent, ConocoPhillips up 1.6 percent. The refiners and producers are winning. But the clean energy ETFs — ICLN is down 1.4 percent, Enphase down 3.5 percent, First Solar down 4.1 percent. Luna: That's the clean energy divergence we've talked about before. But it's getting more extreme. Lucas: It is. And I think the weather angle actually reinforces it. When you have a heatwave, the immediate beneficiary is conventional power generation — natural gas, coal, and oil-fired peaker plants. Solar actually performs worse during heatwaves because high temperatures reduce panel efficiency. So the market is pricing in near-term demand for fossil fuels, not long-term transitions. Luna: If this episode helped you make sense of what's happening in energy markets — and honestly, it's a confusing moment — the way we keep this show free and ad-free is through listener support. You can buy us a coffee at buy me a coffee dot com slash fexingo. It's a small gesture that makes a big difference. Lucas: And seriously, even a few dollars helps us keep doing the deep dives without commercial breaks. So if you found the weather-oil connection useful, consider it. We really appreciate it. Luna: Alright, back to the data. One thing I want to point out: the El Niño forecast. The Climate Prediction Center says there's a 70 percent chance of a strong El Niño persisting through the Northern Hemisphere winter. That typically means more storms in the Gulf, which could disrupt oil production and refining. Lucas: That's the real wildcard. If we get a busy hurricane season in the Gulf of Mexico, we could see a supply shock on top of the demand shock. And that's when oil really takes off. Luna: Are we already seeing that in the options market? Lucas: We are. The volatility skew for WTI options has shifted — out-of-the-money calls are more expensive, which means traders are hedging against a spike. The implied probability of oil hitting $100 by September has gone up. Luna: So the market is pricing in a weather premium. Lucas: Exactly. And it's not just oil. Look at agricultural commodities — cocoa, coffee, sugar. El Niño typically means drier conditions in Southeast Asia and wetter conditions in parts of South America. That's already affecting palm oil and sugar cane. We're seeing price moves there too. Luna: So the inflation story isn't just about oil. It's about food prices as well. Lucas: Right. And the Fed pays attention to that. The core PCE — which is their preferred inflation gauge — was at 2.6 percent in the latest reading. If energy and food start pushing headline inflation back up, the Fed might have to hold rates higher for longer. Luna: What's your base case for oil from here? Lucas: I think we settle in the $85 to $95 range for the next few months, barring a hurricane or a geopolitical escalation. The weather premium is real, but OPEC+ has spare capacity — they can ramp up production if prices get too high. And demand growth is slowing, especially in China. Luna: But the market seems to be ignoring that spare capacity argument right now. Lucas: Because the market is focused on the immediate — the heatwave, the El Niño, the risks. And that's rational. Spare capacity is a medium-term cushion, not a short-term circuit breaker. If a hurricane hits the Gulf tomorrow, spare capacity in Saudi Arabia doesn't help you for the next two weeks. Luna: So we're in a moment where tail risks are driving the narrative. Lucas: Exactly. And that's why you're seeing the energy sector outperform. Not because the fundamentals are screaming buy, but because the risk premium is expanding. And until we get clarity on the weather front — maybe by September — that premium is likely to persist. Luna: One more thing: the clean energy sell-off. Do you think it's overdone? Lucas: It depends on your time horizon. If you're a long-term investor betting on the energy transition, this is probably a buying opportunity. The Inflation Reduction Act isn't going away. But in the near term, clean energy stocks are fighting against a rising interest rate narrative and a fossil fuels rally. That's a tough combo. Luna: So short-term pain, long-term gain? Lucas: That's the cliché, but it's often true. The key is whether you have the patience to wait out the weather cycle. Luna: Alright, let's leave it there. Next episode we'll dig into the natural gas disconnect — why it's falling when oil is flying. Lucas: And whether that's about to change. See you next time.