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Fears Of Economic Slowdown Cap Crude Prices

Fears Of Economic Slowdown Cap Crude Prices

Tightening monetary policy is expected…

Irina Slav

Irina Slav

Irina is a writer for Oilprice.com with over a decade of experience writing on the oil and gas industry.

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$90 Oil Is Only The Beginning

  • The current move in oil prices is largely attributed to geopolitical risk.
  • The next major move in oil could be triggered if inventories fall to critical levels.
  • Wall Street’s consensus seems to be that Brent will reach $100 by the summer.

Brent crude touched $90 per barrel briefly this week for the first time in years. This latest jump was attributed to tensions around Ukraine, but this is the most transitory reason for oil price rises. The bigger reasons all have to do with fundamentals. And $90 per barrel of Brent may be only the beginning. A lot has been written recently about OPEC's spare capacity and the not too rosy outlook for it. That spare capacity is in decline for several reasons, but chief among them appears to be underinvestment. As a result, JP Morgan earlier this month warned that Brent could rise to $125 per barrel as OPEC's spare production capacity falls to 4 percent of total capacity by the fourth quarter of 2022.

The International Energy Agency has gone even further, warning OPEC spare capacity could fall by half to just 2.6 million bpd in the second half of the year. The agency then went on to say that, "If demand continues to grow strongly or supply disappoints, the low level of stocks and shrinking spare capacity means that oil markets could be in for another volatile year in 2022."

It is not just OPEC, however. The biggest non-OPEC producer of oil—and biggest oil producer globally—is pumping less than it can. Pressure from shareholders on public oil majors in the United States has increased, as has an insistence that companies focus on greening up their operations instead of looking for more oil and gas to extract. As a result, the U.S. is pumping less oil than it could and, many would argue, should.

As a result, the stage seems set for another expensive year in oil, which happens to coincide with an expensive year overall as central banks begin tightening monetary policies in response to stubborn inflation that, like the IEA's oil demand forecasts from the early days of the pandemic, proved to be far from the transitory glitch the Fed said it was last year.

"The oil market is heading for simultaneously low inventories, low spare capacity and still low investment," Morgan Stanley analysts wrote in a note cited by the Wall Street Journal this week, summing up the situation quite nicely. In this situation, $90 for a barrel of Brent may be just the beginning.

Related: Shell’s Gas Trading Booms While Oil Trading Slows

Indeed, the Wall Street consensus seems to be that Brent will reach $100 by the summer because of all the reasons listed by Morgan Stanley and also because breakeven costs are also on the rise, thanks to inflation trends and labor shortages, at least in the United States. Yet the biggest driver of prices will remain physical demand.

The International Energy Agency admitted physical oil demand has proven stronger than previously expected in its latest Oil Market Report. Based on this surprising turn of events, the IEA revised up its 2022 oil demand forecast by 200,000 bpd. And based on its track record, it might well turn out it has once again underestimated demand robustness. Even with this estimate, oil demand will not only return to pre-pandemic levels but exceed them, reaching 99.7 million bpd by the end of the year.

In such a situation, higher prices for oil are all but certain since there is precious little—bar another round of lockdowns which is highly unlikely—anyone can do about them. The question, then, becomes how high oil can go before it begins to go down?

The answer is tricky. U.S. public oil companies are still beholden to their shareholders, who seem to be taking to heart forecasts that oil has no long-term future. They have limited space for doing what they want. Private companies will be drilling as WTI continues climbing higher. And OPEC will be drilling as well, but it may choose to keep controls on production rather than switching to "pump at will," mostly because only a few OPEC members actually have the capacity to pump at will.

Excessively high prices tend to discourage consumption, regardless of the commodity whose prices are getting excessively high. However, there is a caveat, and it is that the commodity must have a viable alternative to discourage consumption when prices rise too high. Judging from Europe's nightmare autumn and winter this year, alternatives to fossil fuels are not yet up to par. This basically means that the impact of high oil prices on demand will be slow to manifest and slow to push prices down.

Where does this leave the world? The short answer is "Not in a good place." Higher oil prices will lift the prices of everything else, and this is the last thing you want—if you're a government—when you're already struggling with inflation. It may well be that the pandemic will end for good this year, but the real fallout from it may only be starting to show.

By Irina Slav for Oilprice.com

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  • Mamdouh Salameh on January 31 2022 said:
    Oil isn’t only here to stay throughout the 21st century and probably far beyond but is also going places. A $90 oil is the first step in a journey which will take Brent crude beyond $120 a barrel in the next few years.

    Why? Because global oil demand is underpinned by a unique combination: the most bullish global oil market since 2014 and strong indications that the oil market has already entered a supercycle phase defined as a sustained expansion usually driven by robust growth in demand.

    Brent crude oil price has risen above $91 a barrel and could be expected to touch $100 by the fourth quarter of 2022 or the first quarter of 2023 because of an oil market getting tighter and a global spare production capacity getting smaller.

    OPEC+ is fully aware that by the time it has fully recovered all the production cuts of some 10.0 million barrels a day (mbd) that it had implemented at the height of the pandemic in April 2020 it could end up with a spare capacity estimated at around 2.0 mbd.

    In the short-term, OPEC+ has enough capacity to keep the oil market balanced and prevent Brent crude from going beyond $100 in 2022 and 2023. In the long-term, OPEC+ particularly the Arab Gulf members and Russia has no alternative but to invest heavily in exploration and production expansion. And since it takes up to five years before such investments reach fruition, the market is bound to experience some severe tightness that will push process further upwards.

    The other source of new additional capacity could technically come from rising US shale oil production. However, I doubt very much that we could ever see a comeback of shale oil to around pre-pandemic levels. The reason is that the sweet spots in the US shale plays have already been used and now drillers are moving to poorer and less productive spots. Another reason is that with the sweet spots gone, well productivity has declined. A third reason is that shale drillers don’t have the same access to capital as before the pandemic because investors want a healthy return on their capital and not just reckless and unprofitable production.

    And while rising oil prices could increase costs of manufacturing, we need to look at the wider picture. The global economy benefits a lot from reasonably high oil prices but it is also capable of telling world in no uncertain terms when a certain price level will harm it exactly as it did when Brent crude hit $147 a barrel in 2008 and almost brought the global economy to its knees. A fair Brent crude oil price, in my opinion, ranges from $110-$130 a barrel.

    The global economy is made up of three major chunks: (i) global investments; (ii) the global oil industry and (iii) the economies of the oil-producing countries all of which are invigorated by rising oil prices.

    Dr Mamdouh G Salameh
    International Oil Economist
    Visiting Professor of Energy Economics at ESCP Europe Business School, London
  • DoRight Deikins on January 31 2022 said:
    « As a result, the stage seems set for another expensive year in oil, which happens to coincide with an expensive year overall as central banks begin tightening monetary policies in response to stubborn inflation that, like the IEA's oil demand forecasts from the early days of the pandemic, proved to be far from the transitory glitch the Fed said it was last year. »

    Who would have thought that inflation and oil prices might coincide? Luckily we can produce lots of wind turbines, solar panels, and dams that just magically appear without using any steel, copper, concrete, or energy!
  • Bill Simpson on February 01 2022 said:
    No matter how much oil cost, you can only reduce consumption of oil a little before that reduction in available energy needed to perform needed work forces the entire global economy to shrink. That is known as a recession.
    So soon, we could be looking at a shrinking economy, and inflation at the same time. Should the recession get severe enough, the servicing of debt could become a dangerous problem for the entire financial system.

Leave a comment




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