The reversal in global oil markets could be short-lived
As an energy crisis engulfs Europe, global oil markets have offered modest relief, with crude prices falling as traders worry about the global economy. But the turning point is likely to be short-lived.
For now, cheaper oil is being welcomed by world leaders who have been battling high inflation for decades. US President Joe Biden, whose approval ratings dipped as gas prices soared a few months ago, hasn’t wasted the opportunity to tell Americans their car is getting cheaper again.
Oil markets have avoided the doomsday scenarios that energy analysts warned of just six months ago, when a 1970s-style shock seemed inevitable as rampantly rising post-pandemic demand met the possibility of a new supply disruption.
JPMorgan said Brent oil could hit $300 a barrel if Western sanctions on Russia lead to a major shutdown of the country’s oil sector. But it was trading at $99.72 a barrel on Wednesday, down more than 28% from this year’s high of nearly $140, hit in the days after Ukraine invaded Ukraine. Russia in February.
That’s still a lot to pay for oil – nearly double the long-term average price, and more than enough to continue generating profits for Texas producers in the Kremlin. Yet a price shock it is not.
But no one should be too optimistic about the market downturn. Oil prices can fall for good reasons, such as technological breakthroughs that reduce demand or release more supply, as well as for bad reasons, such as recession. And this oil market is not in very good shape.
Today’s price is falling not because supply is plentiful, but because soaring inflation and rising interest rates are raising fears of a recession, especially in Europe.
Tepid oil demand in China is also weighing on a market that has grown to depend on the country’s relentless thirst for more crude.
Where supply is robust, it’s unexpectedly – like in Russia, where Western sanctions have barely scratched the oil sector – or abnormally, like in the United States, where Biden has ordered that oil from of a federal emergency stock is poured into the market. This has helped cap prices, but a market brought under control by a government’s decision to release historic volumes of emergency oil is not a natural situation.
Some of these bearish factors have an expiration date. The US stock release program ends in November and the emergency reserve will need to be replenished. In December, Europe and the UK are to ban insurance for vessels carrying Russian crude – a move that could significantly reduce Russian exports, unlike sanctions so far.
Economic fears are not yet affecting demand. A deep recession could upend all the fundamentals of commodity markets, like in the 1980s, when scarcity gave way to nearly a decade of plenty. But short recessions tend to reduce oil demand only briefly: when economies rebound, so does consumption.
Meanwhile, the supply and demand fundamentals that scared oil analysts so much a few months ago continue to lurk beneath the surface of the market. OPEC’s spare production capacity – the source of its market power for decades – is shrinking. Even the cartel’s production is now well below its own quotas, as that of some members is in terminal decline.
OPEC’s anchor producer Saudi Arabia, which has significant spare capacity to deploy, is already considering further production cuts to support prices – an idea that will alarm consuming countries and could simply neutralize any additional oil from Iran, if sanctions are eased on its industry.
Investment in new non-OPEC production remains sluggish. Wall Street is reluctant to fund more fossil fuel projects that climate policy could render obsolete. Supermajors are investing less capital upstream than before the pandemic.
Investors are forcing once-prolific U.S. shale operators to spend their windfall from higher prices this year on dividends, not on expensive new drilling. Gone are the days when they could drill enough wells to meet all the additional global demand.
Dwindling supplies of fossil fuels from producers might seem like good news for the climate. But not if it induces a price shock like the one Europe is facing with gas, forcing governments to subsidize consumption. Moreover, consumers are showing few signs of abandoning oil in the short term. Global demand is expected to reach pre-pandemic levels again this year, then rise again in 2023.
The offer will be hard to follow. A recession or the release of more emergency oil could mask this reality for a while. But that will only make the next upcycle more severe.