With the Omicron variant continuing to spread around the world, will a drop in oil prices follow? Maybe, but probably only in the short term.
Equity markets tanked Friday, 26 November 2021, on fears that the Omicron variant, first identified in South Africa, would sharply impact worldwide economic output. The nearly 1,000-point loss in the Dow wiped nearly $90 billion of value in Dow equities. Oil prices were particularly hit hard, dropping nearly 10% from Thursday’s close.
That drop, however, was minor compared to what happened to prices in early 2020, when at the end of April oil prices had dropped nearly 70% in value. This was frightening and was a combined pessimistic response to fears of demand destruction due to the coronavirus and the price war initiated by OPEC and Russia to counter rising production from US shale oil producers.
As a world economy, we had not faced a major health crisis since 2014 when Ebola fears gripped the world and in 2009 when H1N1 flu sickened 60.8 million and killed 12,469 in the US, according to the US Centers for Disease Control and Prevention (CDC).
If we go back to the 1918 Spanish flu, Fig. 1 shows the gross US demographic impact of these pandemics.
The 1918 Spanish flu infected about 28% of the US population but did not impact oil prices to any great degree. COVID-19 has infected about 15% of our fellow citizens but has caused nearly 125,000 more deaths because our population is about three times larger than it was in 1918.
In our current COVID-19 pandemic, images of first responders desperately improvising to save lives, stories of grief-stricken children, and partners forced to provide remote comfort to isolated and suffering elders tested our confidence that there would ever be a “normal” American life in the future.
How Did Oil Markets React?
The pre-COVID price of oil (CLF) in late 2019 dropped by 73% to its low in April 2020. Fears of demand destruction due to COVID dropped the price from $63/bbl to around $40/bbl—a 36% drop (Fig. 2).
Price pressure was further exacerbated by OPEC’s price war with Russia, with OPEC increasing its output by a factor of four during a short window going into and lasting through April 2020. This dropped the price of oil another 40–50%.
Once OPEC ended its price war, the baseline price of oil was around $40/bbl.
When Moderna and Pfizer announced their vaccines, and the CDC authorized their emergency use, prices recovered until late July 2021 when the US entered its third wave of increasing case counts and rising death counts.
Prices dropped about 16% before staging an astounding recovery to a 4-year high of nearly $84/bbl in mid-October 2021.
Now we have the Omicron variant. The market’s virus fears resulted in a drop from $74/bbl on its 26 November opening to midday pricing of $65/bbl on 30 November—a 3-trading-day drop of about 12%.
Our first pandemic oil price drop occurred when nothing about the potential impact of COVID, or treatments for it, was known. If we were in the same state of unpreparedness now, we could see the previous pandemic fear factor of 36% drop the price from here to the low $50/bbl, high $40/bbl range.
However, given that we have vaccines, monoclonal antibodies, new therapies, and better testing, my guess just after Thanksgiving was that our original fear discount would not apply now, and that we would see some, but not a lot of, price weakness from here.
The price of WTI as of midday 23 December had recovered to $73.46/bbl—a virus “discount” of only 6% from price levels pre-Omicron awareness.
Commentary on oil prices has always seemed, at least to me, to place relatively equal weights on demand and on supply in assessing the major moves in oil prices.
Yet, recent volatility in the oil markets would imply that the supply side of the equation is far more important.
Fig. 3 shows US well-starts over time. We are still well behind the pace of drilling that was supported 3 years ago.
The capital discipline that publicly traded operators are showing in restraining new drilling activity in the face of Wall Street pressure to improve balance sheets and return money to shareholders would suggest that there should be little fear that US producers are going to flood the market with new crude.
However, privately held companies will probably ramp up production, mainly through completion of drilled-but-uncompleted wells, to take advantage of improving prices. US supply growth seems inevitable but not out of control.
The slow increase of day rates, especially for higher-horsepower rigs, might be a bit of headwind for privately held operators looking to aggressively add supply, especially in the Permian (Fig. 4).
But average day rates across all basins have still not reached levels seen in mid-2019. And rates in Appalachia for higher-horsepower rigs, although modestly increasing, are still from 14 to 16% lower than in late 2019.
Enverus Intelligence Research’s 17 December 2021 report expects that inflation coupled with central bank monetary policies strengthening the dollar will soften demand in the first part of 2022, but OPEC’s determination to defend prices in the face of US supply growth of 800,000 B/D to 1 million B/D by manipulating its supply to world markets will provide a solid price foundation through 2022.
While demand is driven by tens of thousands of competing, connected economic factors (any one of which can be the oil price driver du jour), supply is controlled by fewer entities.
This gives them dominant control of pricing, and it is supply that should be our focus as we attempt to read the oil price tea leaves.
Before cofounding Enverus (formerly DrillingInfo) in 1999, Mark Nibbelink had a long career as a prospect geophysicist starting with Gulf Oil in 1972. He routinely solicits advice and commentary from many Enverus internal sources; however, his commentary is personal and should not be construed as official Enverus perspective.He holds a BA in geology and a master’s in geology and geophysics, both from Dartmouth College.