Amid the energy crisis engulfing Europe, international oil markets have taken a slight breather as prices have retreated on traders’ concerns about the global economy. However, the turnaround may be short-lived.
For now, cheaper oil is being welcomed by world leaders struggling with the highest inflation rates in decades. US President Joe Biden, whose approval ratings plunged when gas prices rose a few months ago, wasted no opportunity to tell Americans that their car journeys have become cheaper again.
Oil markets have not fallen into the doomsday scenarios that energy analysts were warning about just six months ago, when a 1970s-style crash seemed inevitable in the face of runaway post-pandemic demand and the possibility of further supply disruptions.
Oil majors have poured less capital into production than before the pandemic.
J.P. Morgan forecast that benchmark Brent crude oil could hit $300 a barrel if Western sanctions on Russia trigger a major shutdown in the country’s oil industry. On Wednesday (24), it closed at $101.22, down 28 per cent from its 2022 high of about $140, days after Russia invaded Ukraine in February.
That’s still a high price to pay for oil: almost double the long-term average price and more than enough to keep generating profits for producers everywhere from Texas to the Kremlin. Still, it is far from a price shock.
But no one should be too optimistic about the current, more muted market. Oil prices can fall for good reasons (such as technological advances that reduce demand or free up more supply), but also for bad reasons, such as a recession. And the current oil market is not in good shape.
The price is falling not because there is too much supply, but because rising inflation and interest rates raise fears of a recession, especially in Europe.
Also weighing on the current sluggish demand for oil in China, in a market that has come to depend on the country’s relentless thirst for oil.
Where there is ample supply, it comes either unexpectedly, as in Russia, where Western sanctions have barely affected the oil sector, or unnaturally, as in the United States, where Biden has decreed that oil from emergency national reserves be dumped on the market. This has helped to contain prices, but a market that is kept in check by a government’s decision is not a natural situation.
Some of the factors holding back prices have an expiry date. The US emergency oil release programme ends in November, and these stocks will need to be replenished. In December, Europe and the UK will ban the insuring of ships carrying oil from Russia, a move that could reduce Russian exports to an extent that sanctions have so far failed to achieve.
Indeed, fears over the economy have not yet affected demand. A deep recession could turn all commodity market fundamentals upside down, as in the 1980s. But short recessions tend to reduce oil demand only for a time: when economies recover, so does consumption.
For their part, the supply and demand fundamentals that so frightened oil analysts a few months ago continue to lurk beneath the market’s surface. Idle production capacity in the Organisation of the Petroleum Exporting Countries (OPEC) is shrinking. Even the cartel’s actual production is now well below its own quotas.
OPEC’s top producer, Saudi Arabia, which has plenty of spare production capacity, is already discussing further production cuts to support prices, an idea that could neutralise any extra oil from Iran if sanctions on the country are eased.
Investment in new production outside OPEC remains weak. Wall Street is reluctant to finance more fossil fuel projects that could be rendered obsolete by climate policies. Oil majors have committed less capital to production than before the pandemic. Investors are forcing formerly prolific US shale oil producers to spend the bonanza they have gained from this year’s high prices on dividends, not costly new drilling.
A reduced supply of fossil fuels from producers might seem like good news for the climate. It will not be, however, if it induces a price shock like the one Europe is facing with gas, forcing governments to subsidise consumption. Moreover, consumers show little sign of moving away from oil in the short term.
There will be difficulties in maintaining supply. A recession or the release of more emergency oil may even mask this reality for some time. But this will only make the next high cycle more severe.
In Portos e Navios