🛢How high will oil prices go?

Oil prices reached $130 per barrel but geopolitics may push it even higher

Scenario of oil prices reaching $100 per barrel looked highly unlikely in 2021 but here we are. Even as the Russian invasion of Ukraine began to progress, many believed that prices will not shoot past $120 per barrel. All of those unlikely scenarios materialized with prices quickly surpassing initial forecasts. However, unlike many other commodities, crude prices have not yet reached all-time highs. The question is - how high will oil prices go?

How much oil supply is in danger?

• Russia's oil output amounts to around 10 million barrels per day with half of it being exported as crude oil and around 3 million barrels per day as oil-derivative products

• Oil market needs to be relatively balanced in order to prevent price volatility, resulting from demand and supply shocks

• Russia exports around 2m bpd via pipelines and around 6m bpd via tankers

• Exports to EU amount to around 4m bpd, with around 1m bpd being exported via pipeline

• Western companies begin to self-sanction and refuse to purchase Russian oil on the spot market. This could lead to around 3m bpd of Russian exports being frozen

• Taking a look at history, it would be the fifth largest oil supply shock. Supply shock that came after Iraq invaded Kuwait in 1990s was bigger

• Situation is not accompanied by demand shock as global oil demand still have not recovered to pre-pandemic levels

• World, especially Europe, will try to reduce oil consumption and will also look for supply elsewhere

• Current situation is different from 2007-2008 demand shock but we can learn a lot about demand destruction from that period

90s oil shock vs current situation

Around 4.5m bpd of oil was "frozen" in the aftermath of Iraqi invasion of Kuwait in 1990s, what accounted for around 7-8% of global demand back then. In theory, the current situation is very similar. While the amount of oil in danger is smaller, the biggest risk is that the majority of this oil was exported to Europe. Oil prices jumped 140% after the Iraqi invasion was launched but have pulled back to pre-invasion levels in less than 1 year.

Current situation is similar to the oil shock of the 1990s (Iraq-Kuwait war). Assuming that prices will continue to behave similarly, peak may be reached near $150 per barrel (new all-time highs). Of course, the past cannot be treated as an indicator of the future. Source: Bloomberg, XTB

2007-2008 demand shock bs current situation

As we have already explained, factors that led to oil price spike in 2007-2008 were different from factors leading to oil price spike now. Nevertheless, some similarities can be found - supply also struggled to catch up with rising demand ahead of the Russian invasion of Ukraine. Nevertheless, a key similarity is that the current situation may lead to demand destruction just as the 2007-2008 period did. 

Price action now is similar to the one from 2007-2008 but there are 2 big exceptions. Price gains accelerated following November 2021 correction, what may hint at the market overheating. Still, the possibility of oil prices reaching $150 per barrel cannot be ruled out. Source: Bloomberg, XTB

Where to look for demand destruction?

Goldman Sachs released an interesting analysis of prices and demand destruction. GS thinks that oil prices reaching $200 per barrel would lead to a balanced market via destruction of 5-6m bpd demand (Russian exports).The bank expects oil price to average $135 per barrel in 2022 and trade in $115-175 price range.

Earlier, we indicated approx. 3 million barrels per day of the frozen supply for Europe, which, if spread all over the world (China imports more from Russia, Europe is looking for other sources), gives us a price of approx. USD 165 per barrel. However, if supply is limited only to developed countries, demand destruction may not start until prices reach $215 per barrel. It should be noted that demand destruction ends in recession.

Will China buy more Russian oil? Where can Europe look for substitutes?

China

• China is able to purchases all of Russian oil that Europe does not want

• China is currently importing around 10 million barrels of oil per day. However, it imported 12.7m bpd at peak

• Increased imports may allow to refill reserves that have dropped by around 100 million barrels since peak in November 2020

• Russia exports most of its oil via LR and MR tankers. Russian oil exports require around 10% of the global fleet of such ships. China twice as many such tankers as required

• However, high freight prices could pose a challenge

Europe

• Nuclear deal with Iran. Iran has around 100 million barrels of oil in off-shore storage. Reaching agreement could bring 0.5-1.5%

• US is in advanced talks with Venezuela over lifting oil sanctions. Venezuela could double its production, to around 1.5m bpd, if sanctions are lifted. US wants Venezuelan oil to be shipped directly to the United States, what would allow 1-1.5m bpd of US supply to be shipped to Europe

• Number of active oil rigs in the United States sits at around 500. In pre-Covid times it was over 800. Each active rig amounts to average of 1k bpd of increase production. US shale producers could boost production by around 300k bpd this year. EIA expects it to be 200k bpd

• OPEC+ output is around 700k bpd lower than agreed on. However, this is result of issues with restoring production

• OPEC has around 5m bpd of spare production capacity with half of that being in Saudi Arabia, UAE and Iraq

Spare production capacity in OPEC amounts to around 5m bpd but only half of those could be brought back to market. Source: xStation5

How much will we pay for oil?

It is still unsure whether Russia will decide to ban exports of energy commodities or not. However, western companies began to self-sanction themselves and stopped purchases of Russian oil on the spot market. If supply of up to 3m bpd is frozen, a price jump to $150-165 per barrel is a real possibility. However, if more than 3m bpd of supply is frozen, a price jump above $200 per barrel cannot be ruled out. On the other hand, if China boost purchases of Russian oil while other producers boost production and start selling more to Europe, oil prices may drop below $100 as soon as this year.

Oil prices returned towards 2012 highs. However, a move to fresh all-time highs or even past $165. On the other hand, the optimistic scenario calls for a drop back below $100 per barrel, where oil traded before the Russian invasion of Ukraine. Nevertheless, the market remains tight and prices are prone to volatile moves. Source: xStation5