Recent trend in oil prices

September 21, 2021 0 admin

Overview

Crude oil, or “black gold”, holds a prominent position in the global commodities market despite the continued efforts to reduce its use and to find alternative green energy sources. Oil price movements are closely watched by policymakers, oil companies, investors, traders, and consumers. Sudden changes in oil prices affect the global economy at every level – from a family’s budget to a nation’s GDP – reflecting its stature as a prominent global commodity.

Like most commodities, the key driver for the oil price is its supply and demand in the world. Supply is somewhat controlled by a cartel of oil-producing nations called OPEC, while demand is supported by everything from traveling to electricity generation. Prices are also moved by geopolitical developments and market sentiments.

Crude oil prices react to a variety of geopolitical and economic events

Source: U.S. Energy Information Administration

Demand was impacted by COVID-19 lockdowns globally

During the first half of 2020, worldwide demand for oil fell rapidly as governments ordered lockdowns and restricted travel to prevent the spread of the COVID-19 pandemic.

In the first four months of 2020, global petroleum consumption fell by 21%. In April 2020, the lowest demand and the supply glut led to an unprecedented collapse in oil prices, forcing the WTI futures to turn negative (-$38 a barrel on 20th April) for the first time in history, prompting producers to literally pay buyers to take the commodity off their hands.

Impact of COVID-19 lockdown on oil prices

Global petroleum and other liquids production and consumption

 Source: U.S. Energy Information Administration

By the summer of 2020, oil prices began to rebound as nations emerged from lockdown and the OPEC agreed to significant cuts in crude oil production. Petroleum consumption increased 16% in the next three months after its lowest level of the year in April 2020.

Recovery fueled by unlocks and vaccinations

By end 2020, easing lockdowns and optimism over the possible rollout of multiple COVID-19 vaccines buoyed the market. Brent oil futures climbed by more than 150% from its April 2020 low and settled at $52, while WTI futures settled at $49 at the end of 2020.

Oil price movement (last 1 year)

The recovery continued in 2021 driven by increasing business activities and vaccinations. Continued economic rebound reflected by JPMorgan Global Composite PMI remaining above 50 throughout last one year – a level which was last seen in January 2020, before COVID-19 pandemic hampered global economic activities. Similarly, oil futures continued their recovery and reached its 2-year highest level on 5th July 2021, when brent oil futures and WTI futures closed at $77 and $76 per barrel respectively, registering 49% and 57% gain YTD respectively.

Economic rebound supports price recovery

JPMorgan Global Composite PMI

Source: U.S. Energy Information Administration                                                                                  Source: Trading Economics

However, this stellar recovery was disrupted by the spread of delta variant and resurgence of COVID-19 cases around the world in the last 1-2 months. As of August 2021 end, the futures were trading at more than 7% below their peak in July.

OPEC & Non-OPEC vs. market forces

In July 2021, the OPEC cartel contributed around 33% of the global production of petroleum and other liquids. As per the EIA, oil exports by the cartel, which has around 80% of world’s proven crude oil reserve, represent about 60% of the total petroleum traded globally. This dominant position reflects the cartel having a significant influence on oil price movement.

Petroleum and other liquids production

 Source: U.S. Energy Information Administration

The top oil-producing non-OPEC countries including the US, Canada, and China have limited capacity to export given their high domestic consumption, limiting their influence on short-term oil price movement.

Oil prices are also affected by geopolitical developments and economic uncertainties that impact the supply-demand paradigm. For instance, in March 2020, the world’s largest exporter Saudi Arabia and second-largest exporter Russia failed to reach an agreement on cutting production to stabilize the oil price. After Saudi Arabia ramped up its production in retaliation, a sudden increase in supply – at a time when demand was falling amidst the COVID-19 pandemic – resulted in the crash of oil prices in April 2020. An “extraordinary” meeting between OPEC and non-OPEC (mainly between these two nations) led to an agreement to cut output by 10 million barrels per day that fueled short-term price recovery.

Climate concerns and oil majors’ shifting focus to renewables restricting production

Oil production of the world’s giant oil corporations – also known as supermajors – was impacted by increasing climate change concerns and moves to switching to renewable energy production.

Investors are demanding that the companies spend less on drilling and instead return to shareholders. Companies are facing pressure to be cautious on climate change, as evidenced from ExxonMobil’s shareholders’ meeting in May 2021, where one small activist investor (a hedge fund named Engine No.1 which owns a meager 0.02% of ExxonMobil), pushing the company to increase investments in renewable energy, was able to secure the support of other investors including asset-management powerhouse BlackRock, and ended up appointing three of its four director candidates to the Exxon board. Another oil giant, Royal Dutch Shell, lost a legal case against the environment group in May this year when a court in Netherland told the company to cut its CO2 emissions by 45% by 2030, compared to 2019 levels – something that would force it to cut oil production.

Supermajors’ oil production is in a declining trend for the last 1-2 years. Prior to the court ruling, Shell had already indicated a 1%-2% reduction in oil production each year after registering the peak level in 2019. As of Q2 2021, the daily oil production of large oil companies declined by nearly 9% from their 2019 level even if the demand recovered significantly in the last year.

Decreasing oil production

Increasing investment in renewables

Source: Refinitiv Eikon                                                                                                            Source: Westwood Global Energy/IEA/Windpower Monthly

Being already under pressure to lead the energy transition to low-carbon energy sources, the oil giants speeded up their investments in renewables. European giants like Total, BP, and Shell have already begun to prioritize this trend, and plan to reduce greenhouse gas emissions to net-zero by 2050. Total aims to become a “green energy major” by executing its 100GW renewable energy generation target by 2030 which would place it among the top five green-energy players globally. BP and Shell have also announced major offshore wind projects in 2020.

Bottom-line

The dynamics of the oil economy are complex as oil prices depend on more than the rules of demand and supply. However, the 2020 price war episode reaffirms the fact that market forces are more powerful than any cartel.

OPEC’s grip on the market has loosened some in past years. However, its share of the global market allows it to continue to be a central player in oil price determination, despite challenges such as fracking technology and oil discovery in non-OPEC regions.

Climate change worries are here to stay as a growing number of oil majors are seeking to foray into low-carbon alternative energy sources. The Dutch court ruling could give a signal to other EU companies to make progress on the sustainability journey. This could have a catastrophic impact on the industry given the importance of European oil majors to supplies.

However, energy transition is a very slow process as it requires oil prices to be high enough to make clean energy alternatives competitive. Energy news site oilprice.com reported that oil firms are still grappling with the best way to presently use dwindling cash flows as green infrastructure is 1.5-3.0x more capital and labor-intensive than hydrocarbons.

Activist investor Engine No. 1 garnered a lot of media attention after it succeeded to foray into Exxon’s board, but was not able to guide precisely on profitable clean-energy opportunities the company should invest in. Such activism may be an impediment to the world’s ability to deal with climate change. It may also lead to a volatile price run, fueling inflation and ultimately affecting households, industries, and economies.

As per International Energy Agency (IEA), the supply growth forecast through the rest of this year “comes nowhere close to matching” the expected increase in demand. As Non-OPEC output fails to rebound, the cartel is likely to continue adding more supply to fill the gap which may lead to market share gain for other giants like Saudi Aramco and Rosneft. The possible return of Iranian barrels in the market may also support the supply level.

However, IEA said more recently in August 2021 that the recent spike in the delta coronavirus cases threatens to slow a demand recovery for the rest of 2021, while OPEC predicted strong demand recovery so far.

Reuters survey expects brent would average at $68.02 a barrel in 2021 versus its July forecast of $68.76, registering the first downward revision to the 2021 price view since November 2020. WTI crude would average at $65.63 in 2021, lower than its July forecast of $66.13, amid a slow recovery in production. For 2022, EIA expects prices would be lower than the 2021 level, as production growth from OPEC+ and US would outpace decelerating consumption growth.