Ideas & Debate

Why the world is heading for high oil prices

oil-crude
george wachira_img

Summary

  • Recently global oil prices have been settling above $60 per barrel, a high price relative to below $45 prices that have persisted through the last one year of the Covid-19 pandemic.
  • In fact, the Brent marker crude oil hit $66 per barrel end of last week, as oil commodity traders and hedge fund managers continued to talk-up the prices as they predicted prices above $70.

Recently global oil prices have been settling above $60 per barrel, a high price relative to below $45 prices that have persisted through the last one year of the Covid-19 pandemic. In fact, the Brent marker crude oil hit $66 per barrel end of last week, as oil commodity traders and hedge fund managers continued to talk-up the prices as they predicted prices above $70.

In Kenya, the pump prices announced by EPRA (Energy and Petroleum Regulatory Authority) on February 14 were based on an average crude oil price of $55 which implies we should expect EPRA to publish higher pump prices in mid-March based on higher crude oil prices.

Predicting oil prices is nowhere near a science. There is a lot of judgement and in most cases serve-serving speculation intended to influence and drive markets. Oil traders usually commit deliveries in the future with prices very much influenced by speculation. This causes up/down price swings which at times have little bearing with the real market supply/demand fundamentals.

When global oil supply/production is in surplus, prices should settle low. When the reverse is the situation, prices will increase. When oil demands are high and supply is lagging, prices will go up. Prices drop when oil demands are sluggish. Markets and prices eventually find stable and predictable levels defined by these supply/demand situations.

Let us analyse what has been driving prices lately. The oil supply cartel Organization of Petroleum Exporting Countries (OPEC) plus Russia have by consensus been suppressing production/supply to maintain reasonably high oil prices. When the group recently decided to gradually increase production, Saudi Arabia unilaterally decreased production by 1 million barrels per day in the months of February and March 2021. Most of the price increases that we witnessed in January and February were because of the Saudi crude oil production reduction.

If in April the Saudis decide to reverse the 1 million bpd reduction, it will increase global supplies and directionally soften prices. It is also expected that at prices above $60, the other OPEC producers (and Russia) will wish to accelerate production increases to benefit from the high prices. And the same may be the case with the US shale oil producers who are likely to be motivated to produce more oil.

Therefore, in the shorter-term, oil supply will directionally increase, as those producers with spare production capacity ramp up more production. This will slow down price increases, or even lower prices.

These short-term production increases are different from the longer-term oil production reductions due to deferred or cancelled upstream investments which were influenced by medium- and long-term decisions made by numerous oil companies in the past one year when Covid-19 pandemic destroyed much of global oil demands. There are also longer-term decisions to reduce future oil production influenced by the impeding energy transition from oil to renewables.

On the demand side we have the positive Biden and Vaccine influences which are boosting economic revival and increased oil demands in USA and the rest of the world. Specifically, the rollout of Covid-19 vaccinations around the world will revive international travel and aviation fuels demands which are still slow in recovering.

The Biden’s $ 1.9 trillion stimulus spend (when approved) is expected to revive economic activities and oil demands, and this will harden oil prices. China on its part is already delivering significant increases in oil demands due to faster successes with covid-19 suppression and revival of economic activities.

My gut feel is that the current $60 plus prices will prompt oil producers with existing spare capacity to increase production for quick cash flow gains. This will likely balance out the oil demand gains from economic optimism created by President Bidden and Covid-19 vaccination. All this is likely to keep prices stable between $60-65 -until something else unforeseen upsets the supply/demand balance.

What are the implications of the price increases in our region? I doubt if prices in the US$60-65 range will immediately accelerate commitments of investment decisions on Uganda and Turkana oil developments. High prices must be sustained over time to allow longer term investment decisions. Moreover, there are wider global considerations by individual investors that may delay investment decisions.