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

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.