European Brent oil almost reached $130/bbl in early March, the highest price seen since July 2008 (Fig. 1). The recent surge was driven in part by rising geopolitical tensions following Russia’s invasion of Ukraine. Rising prices have had widespread economic impacts, with the US reporting the fastest rise in gasoline prices since Hurricane Katrina in 2005. Analysis of geopolitical events such as the Arab Spring indicate that these high prices could be here to stay (Abdel-Latif & El-Gamal 2019).
Sanctions have further complicated matters. Traders appear wary to buy Russian oil, and financial and shipping restrictions have pummeled the Russian energy industry. Sanctions could translate into regional fuel shortages if the drop in Russian exports is not offset by other sources.
New supply has not yet been forthcoming and industry reaction to potential shortages has been mixed. Several countries have released strategic reserves but both the Organization of the Petroleum Exporting Countries (OPEC) and US shale companies remaining hesitant to boost production even in light of rapidly rising prices.
However, even if production does rise and the impact of sanctions on Russian crude moderate, the market has tightened substantially through 2021 and into 2022. Even with an easing of hostilities, oil prices could remain elevated for months or years. That would be a massive shift from the post-2014 lower-for-longer price regime.
Market Fundamentals Will Remain Tight for the Foreseeable Future
Looking beyond geopolitical tensions, market fundamentals support a bullish outlook for prices. Four trends should support higher prices: Modest production growth, the slow uptick in investment, OPEC’s unwillingness to leverage its surplus capacity, and tight global fuel inventories.
1. Production Has Not Caught Up to Pre-COVID Levels
Global oil and petroleum liquids production peaked at almost 102 million B/D in November 2019. Production fell to 90 million B/D in early 2021, the peak of COVID-19’s impact on energy markets and has subsequently partially rebounded (Fig. 2). However, despite oil prices trading above 2019 levels for 9 months straight, production has yet to fully recover. US oil production is expected to rise by 8% through 2022, but less than 4% globally—well under projected economic growth rates that influence energy demand.
2. Global Oil and Gas Investment Is Increasing Slowly
Higher oil prices will likely spur drilling in places like the US, with moderating spend and capital discipline being replaced with renewed optimism. However, it may take some time for that optimism to turn into production. Industry analysts project that it could take US shale over a year to boost production by 1 million B/D even at $100 oil. Additional investment will be needed to sustain that production growth in the longer term because shale’s drilled-but-uncompleted (DUC) inventory has been declining for over a year. Looking at the Permian, more wells have been completed than drilled since August 2020 and the DUC count has fallen by 60% over that period. The trend is broadly true for other oil basins as well (Fig. 3).
3. OPEC+ Remains on the Sidelines
OPEC and other countries such as Russia (colloquially referred to as OPEC+) who reduced production to mitigate COVID-19’s demand destruction have refused to take steps to cool the hot oil markets. Instead, the group intends to adhere to its July strategy that calls for modest rises in production.
While there may be some indication that OPEC+ is comfortable in higher prices caused by geopolitical tensions, there are also serious concerns that OPEC+ may not be able to fully restore production to pre-COVID-19 levels—meaning that its vaunted spare capacity is more in theory than in actuality. The group’s production has fallen short of targets since April 2021 (Fig. 4). Unless Iranian barrels reenter the market following a successful negotiation over its nuclear capabilities, OPEC+ production will likely remain below quota, supporting higher oil prices in the short-to-medium term.
4. Global Oil Inventories Are Near 5-Year Lows
The rapid decline in global oil demand in 2020 led to rising inventories of oil and liquid fuels. Data from OECD countries such as the US, UK, Japan, and South Korea indicated that stock levels jumped by 40% in 2020 but have declined rapidly since (Fig. 5). In fact, global commercial inventories fell at the fastest rate in decades and are at lowest seasonal level since 2013. Considering modest production growth and lagging industry investment, inventories could remain tight through the rest of the year, if not longer.
Even If Geopolitical Tensions Decline, Oil Prices Will Likely Remain Elevated
The extent and duration of the geopolitical oil price premium is uncertain, but even once it fades, market fundamentals will likely support higher prices going forward. Lower investment in upstream oil and gas, open questions about OPEC+’ willingness and ability to raise production, and the post-COVID-19 economic rebound are all stressing oil and fuel inventories. While non-OPEC sources such as shale and deepwater may be responsive to higher prices, a substantial rise in production could take months. That means that elevated oil prices are here to stay for at least the short-to-medium term if not longer and a substantial and durable shift from the post-2014 commodity price regime.
References
Abdel-Latif, H. & El-Gamal, M., Financial Liquidity, Geopolitics, and Oil Prices, Energy Economics (2019).
