Reason Why High Oil Prices are Here to Stay

ByMartin

Jun 28, 2022

 Oil prices have been trending higher. During the H1 of 2022, crude oil prices climbed approximately 60%. Part of the increase is relative to the ongoing conflict between Russia and Ukraine. Part of the reason for higher prices is that demand is accelerating, and supply has yet to catch up to demand in the wake of the pandemic. Additionally, investors are unwilling to put capital toward future infrastructure projects related to building oil development. Most of the new money is chasing limited carbon exposure to the environment, limiting the number of newly developed oil rigs.

The Pandemic Whipsawed the Oil Markets

Well before Russia invaded Ukraine, oil prices were rising. In 2021, the WTI crude oil price increased from about $48 per barrel to approximately $76 per barrel. The rally in crude oil prices was driven by an increase in demand relative to supply. Active oil rigs dropped substantially in 2020 as lockdowns terminated demand. The number of people moving through TSA checkpoints dropped significantly during the lockdowns. TSA checkpoint travel numbers are nearly back to levels seen in 2019 before the pandemic generated worldwide lockdowns.

The rebound in demand in 2021 took the oil industry by surprise. People started driving and flying again, but that did not give the oil industry enough time to ramp up its oil production. Active oil rigs in the United States hit a low in August of 2020 near 172 rigs, and a year later, they had doubled, but remained less than 50% of the pre-pandemic levels.

Russia’s Invasion of Ukraine Accelerated Prices

The Russian invasion of Ukraine accelerated the problem. There was already a shortage of oil due to the rebound in consumption relative to production. Before the pandemic, the United States produced more than 13million barrels of oil a day. In the wake of the pandemic, the United States is making just shy of 12 million barrels of oil per day.

The invasion of Ukraine shunned Russian oil from several markets, including many in North America and Europe. In May 2022, the EU agreed that it would no longer accept Russian oil. The lack of Russian oil on the markets is a global issue. According to the International Energy Agency, before the attack, Russia was the world’s largest oil exporter to global markets.

Russia is the third-largest oil producer worldwide, behind only the United States and Saudi Arabia. Russia is also one of the largest exporters of products, including diesel fuel and gasoline. These petroleum products are refined in Russia and then shipped to global destinations. The International Energy Agency says that oil product exports before the invasion were as high as 2.85 million barrels per day.

The conflict with Ukraine has not been short-lived, and it seems poised to continue to perpetuate for the foreseeable future. The conflict has created a significant problem in Europe. According to the International Energy Agency, Russia was the biggest exporter of oil and products to the EU, supplying 2.2 million barrels a day of oil to the EU and 1.2 million barrels a day of products. Oil trading has accelerated, and volatility has spiked. This phenomenon has spilled over into other commodities, driving up volatility in gold trading.

When Will There Be Demand Destruction?

Demand for oil and oil products remains strong as several countries worldwide rebound from the pandemic. One of the issues is that consumers have been cooped up for a long time and are now more than ever interested in traveling. Some are traveling by train and others are traveling by car. It appears that leisure travel has returned to 2019 levels.

According to Time Magazine, at the current booking pace for airline travel, an estimated 1.5 billion more passengers will fly in 2022 compared to 2021. Medium and short flights are up approximately 26% in April compared to the same period in 2019. The increase in demand for flights puts upward pressure on jetfuel needs.

Will Investment in Petroleum Restart?

The lack of new investment in oil and gas supplies has been one of the reasons why prices have accelerated higher. Many investors have shied away from an investment in petroleum production due to a transition to clean energy. There have been some changes to the way investors feel about petroleum markets. The Wall Street Journal reports that in 2021 Quantum fund needed to convince investors that the petroleum industry would still be viable in 5-7 years. Unfortunately, new money will not lead to a sharp increase in production, which likely means that prices will remain elevated. More capital available will likely convince exploration and production companies to dig more oil and gas wells.

Additional factors that will hamper this process include a difficulty in finding labor. There is also the issue of higher costs for oil drilling equipment. The caveat is that the United States and Europe do not fall into a recession. Then most bets are off.

The Bottom Line

Oil prices are high because demand has rebounded quickly, and supply has lagged. The pandemic created a whipsaw in demand. At first, the lockdowns worldwide led to a significant decline in demand for oil as travel sharply declined. To counter the lack of demand, supply decreased. The number of active oil rigs dropped sharply from the beginning of 2020 to the middle of 2020.

Demand started to accelerate as vaccines took hold. Leisure travel in 2022 has now reached levels seen in 2019. Unfortunately, the rebound in demand has not coincided with a sharp rebound in supply. Additionally, in February 2022, Russia invaded Ukraine. Russia supplies nearly 10% of the world’s oil and gas. Countries and regions like the United States and the EU have banned Russian oil, pushing prices higher.

Energy transition has also created buoyed oil prices. The lack of demand to deploy capital to oil and gas infrastructure and toward clean energy may just keep oil prices elevated for the foreseeable future.