After dropping below $70 a barrel (bbl) in early summer, the price of West Texas Intermediate (WTI) crude has been steadily marching higher. Last week, the price breached $90/bbl for the first time in a year, and there are no signs that the rise is slowing.
Further increases would negatively impact consumers, especially for gasoline and transportation costs. While the Federal Reserve’s rate hikes have helped curb inflation, factors like oil supply dynamics are outside their control. Rising oil prices put the Fed’s attempts to engineer a soft landing for the economy in jeopardy.
Why is this happening, and is a return to $100/bbl inevitable?
Pandemic Disrupts Oil Markets
Prior to the COVID-19 pandemic, West Texas Intermediate (WTI) crude mostly traded between $50-$60 per barrel for over a year. When the pandemic hit in early 2020, stay-at-home orders cratered oil demand, causing prices to plunge.
U.S. oil production fell 3 million barrels per day in response. But demand rebounded faster than expected while supply lagged. This imbalance sparked a climb in oil prices that would last for the next two years.
Russia’s Invasion of Ukraine Tightens Supplies
Many countries banned Russian oil imports after its invasion of Ukraine in February 2022. Removing this supply source strained markets, propelling oil over $100 per barrel in spring/summer 2022.
The U.S. responded by releasing a record amount of oil from the Strategic Petroleum Reserve (SPR), temporarily boosting supply. Between the start of the Russian invasion and now, 235 million barrels of oil — representing 40% of the pre-invasion level — have been released from the SPR.
This undoubtedly helped push oil back below $100/bbl, because it helped boost supplies in the market. The price subsequently fell to below $70/bbl by late spring 2023.
But the SPR release was a risky move, because OPEC could simply cut production to compensate for the increase in supply from the SPR. That’s exactly what they did.
OPEC+ Production Cuts Tighten Markets Again
While the SPR release helped lower prices, OPEC+ responded by cutting production to compensate. Russia and Saudi Arabia reduced output significantly, slowly tightening supplies again.
Their recent decision to extend cuts through 2023 surprised markets and rallied prices. But major oil-exporting countries will always do what is in their best interest, and that generally involves pushing oil prices as high as possible — without triggering a global recession.
Extension of the production cuts was a bullish signal for oil, and that brings more speculators into the mix. On top of that, the devastating floods in Libya — one of the Top 20 oil producers in the world — have prevented the export of oil to global markets.
On the supply side, U.S. production continues to rise, and will almost certainly set a new record this year. But that just hasn’t been enough to stay ahead of rising global demand in combination with production cuts from OPEC+.
The other headwind is that we are heading into lower-demand season in the U.S. That, in combination with rising U.S. production, will likely keep the U.S. market well-supplied. That should mitigate the price rise in the U.S., but the price of Brent crude — which is more representative of the global crude oil market — is likely to rise faster.
Limited Options to Tame Prices
With the SPR now severely depleted after record releases, the Biden Administration has limited options to respond to further oil price spikes.
If Russia and Saudi Arabia want oil prices to rise above $100/bbl — which will hurt President Biden as he heads into an election year — they have the power to make that happen. Given their likely preference for a return of Donald Trump to the White House, I expect them to exercise that power.
In summary, OPEC+ supply reductions are the primary accelerator behind renewed oil price momentum nearing $100 per barrel. Absent a change in their stance, oil may continue rallying, presenting challenges for inflation control and economic stability as the U.S. heads into a presidential election year.
By Robert Rapier
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