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Michael Kern is a newswriter and editor at Safehaven.com and Oilprice.com, 

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The Cure For High Oil Prices Might Just Be Higher Oil Prices

  • Oil producers have had a great year with oil prices rallying by as much as 20% in 2022 alone.
  • Higher oil prices could incentivize upstream investments and help push more supply into the market.
  • “Historically, markets led higher by tightening product and crude inventories are difficult to solve absent a demand destruction event or a supply surge, neither of which appears to be on the horizon.”

Fundamentals and geopolitics have pushed oil prices rallying by 20 percent so far this year to levels last seen in the autumn of 2014. The price at over $90 a barrel is up by more than 60 percent from this time last year, and many analysts say that $100 oil is now a matter of when, not if. 

Oil majors and oil-producing countries part of the OPEC+ alliance have seen the benefits of rallying oil prices with huge cash flows and profits, and government oil revenues, respectively.  

While these handsome benefits of the high oil prices are undoubtedly positive for the finances of the supermajors, OPEC members, and Russia, the market is already wondering at what price point demand destruction will kick in. 

At this point, considering the very tight market right now, persistently high oil prices at over $90—and possibly $100 a barrel—could be one of the few ‘cures’ for high oil prices in the medium term. In the longer term, $90, or $100, oil could incentivize more upstream investments, which have been woefully insufficient over the past two years, compared to the now rebounding post-COVID oil demand. 

It could be $100 oil that would ‘cure’ high oil prices. Yet, it’s possible that demand growth will slow down—because of the high oil prices—before producers commit more investments in supply. 

“The only way to balance this market over the medium term remains high oil prices to slow demand growth,” analysts at Energy Aspects wrote in a note to clients this week cited by Bloomberg

Bringing more supply, on the other hand, is now more challenging than before the pandemic. ESG issues and the energy transition for the international majors, as well as the new-found and still-largely-holding capital discipline of U.S. shale producers, combine with supply chain bottlenecks, labor shortages, and cost inflation. $100 oil could unleash a lot more U.S. oil production, in theory, but supply chain constraints and record-high frac sand prices are likely to temper growth, analysts at Rystad Energy say.  

Global investments in supply rose in 2021 compared to 2020 and are expected to rise this year as well, but they will still lag pre-pandemic levels, all forecasters say. The oil majors have not boosted exploration investments too much, while U.S. shale basically needs to raise investment just to keep production flat. According to the International Energy Agency (IEA), the oil majors’ share of overall upstream spending is now at 25 percent, compared with nearly 40 percent in the mid-2010s. 

Unlike oil majors, national oil companies, especially ADNOC of Abu Dhabi and Saudi Aramco, are investing more in new supply as they each look to raise their respective production capacities by 1 million barrels per day (bpd) by the end of this decade. 

In the near term, however, the market fundamentals point that supply is lagging behind the rebound in demand, pushing oil prices higher, together with the threat of a possible disruption in the Russian oil supply due to the Ukraine crisis. 

Analysts say that the short-term cure for high oil prices is for them to reach the point at which they will start to weigh on demand. It seems that we are not there yet.  

During previous upcycles, $80 seemed to be the point at which major oil-consuming countries started to plead with producers for more supply. We are now well past this point, and as pleas with OPEC+ to pump more oil continue, the alliance is not changing course – for now – and the few producers with spare capacity are not compensating for a massive overall under-production at those that lack that capacity. 

Oil could be set for $100 and even more later this year, analysts told CNBC this week. 

“We could be early, but the major cornerstone of our thesis over the next year, or longer, assuming the macro economy holds, is that the oil cycle will price higher until it finds a level of demand destruction,” Michael Tran, commodity and digital intelligence strategist at RBC Capital Markets, wrote in a note carried by CNBC. 

“Historically, markets led higher by tightening product and crude inventories are difficult to solve absent a demand destruction event or a supply surge, neither of which appears to be on the horizon,” according to RBC Capital Markets. 

By Michael Kern for Oilprice.com 

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  • Mamdouh Salameh on February 20 2022 said:
    The soaring crude oil prices are driven first and foremost by a global oil market that is in its most bullish state since 2014 and which has already entered a super-cycle phase that could last up to ten years and take Brent crude to$120 a barrel in the next few years. Geopolitical factors normally play a supporting role that is temporary.

    A fair Brent crude oil price ranges from $100-$110 a barrel. Such a price is good for the global economy as it invigorates the three chunks that make up the economy: (i) global investments; (ii) the global oil industry and (iii) the economies of the oil-producing countries.

    If crude oil prices rise beyond the tolerance level of the global economy, it will let us know in no uncertain terms. In fact this happened twice in recent years. In 2008 Brent crude hit $147 a barrel on the back of excessively booming housing market then but the subprime housing crisis driven by greed and lack of liquidity in US banks resulted in the world’s most serious financial crisis that almost brought the global economy to its knees and also led to a collapse of oil prices. The second event was the 2014 oil price collapse after Brent crude reached $115-$120 a barrel.

    When crude oil prices rise beyond the tolerance level of the global economy, it leads to a gradual destruction of demand which forces prices down to a level acceptable to the global economy and consumers.

    Shortages of commodities particularly oil and gas have been long time coming because of complacency about the rebound of the global economy and underinvestment since 2019. This has translated into a shrinking global spare oil production capacity, tightening market and an accelerating decline in global oil inventories.

    The gap between OPEC+ output and its target levels is reported to have surged by an estimated 900,000 barrels a day (b/d) in January. Still, OPEC+ is doing its utmost to keep the market balanced. OPEC+ has enough spare capacity to keep the oil market balanced in both 2022 and 2023. Beyond that, it urgently needs to add more capacity. This means it has to start investing heavily in expanding capacity immediately as it normally takes up to 5 years before investment reaches fruition.

    Moreover, US shale oil production is a spent force. Despite a rise of Brent crude to almost $95, a comeback of US shale oil production to pre-pandemic level hasn’t materialized. This has far less to do with capital discipline and far more to do with inability to raise production significantly.

    The maximum shale oil production could rise is estimated at 200,000-300,000 barrels a day (b/d) in 2022.

    Dr Mamdouh G Salameh
    International Oil Economist
    Visiting Professor of Energy Economics at ESCP Europe Business School, London
  • DoRight Deikins on February 20 2022 said:
    Demand destruction event and/or supply surge? We can see the the potential supply surge points, Iran; Libya; Nigeria; Venezuela;It's usually the demand destruction event that happens suddenly; unexpectedly; and sadly, catastrophically.

    Though perhaps people could change their life-styles: more walking/less driving; more reading/less TV; more cooking at home; using less and reusing what one has; rather than the next new thing; enjoying each other's company rather than the virtual friendships that are as ephemeral as the winds in Europe. Naw, what are the chances?
  • George Doolittle on February 20 2022 said:
    "still dirt cheap natural gas prices in the USA" meaning the USA is still being flooded with both product and (far more importantly" "a services Industry" meaning yes prices for oil and distillate fuels have soared but transportation is still so cheap that the USA has a truly awesome "surplus" or "inventory build" in modern parlance...to include interesting in "virtual goods" which is an entirely new form of economic activity.

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