Post-pandemic demand and insufficient supply have driven prices above $80 a barrel
When Joe Biden spoke during last year’s presidential election about leading the US in a “transition from oil”, he hardly expected to be asking the world’s crude producers for more supply just 12 months later.
But the US president’s administration has made repeated efforts to drive down oil prices in recent weeks. First came a trip to Riyadh for Jake Sullivan, Biden’s national security adviser, where he asked Saudi Arabia to increase production. Then Jennifer Granholm, Biden’s energy secretary, told the Financial Times in October that the US was considering a price-sapping release of crude from its strategic stockpiles. The White House even contacted some US oil producers to ask how quickly they could bump up output — an awkward move for an administration that many oil executives consider hostile to their sector.
On the eve of the Glasgow climate summit, COP26, that began on Sunday, Biden even floated the prospect of retaliation against Russia and Saudi Arabia if they didn’t increase oil output soon. “What we’re considering doing on that, I’m reluctant to say before I have to do it,” he told reporters.
The open-ended threat will have given the Opec+ oil exporter group something else to ponder when it meets today to decide whether to adjust its production quotas. Most Opec watchers think the group will stick with its existing plan, which is to add 400,000 barrels a day of supply each month as it restores the huge swath of production it agreed — under US pressure — to cut last year to lift prices. If so, it will be a disappointment to Biden.
The president is right to be worried, say industry analysts and investors. Oil prices, already above $80 a barrel, are at their highest level in seven years. While soaring natural gas prices in Europe and Asia have sparked alarm, the oil rally is gathering the kind of momentum that some believe could culminate in an economy-draining spike like that seen in 2008, when prices hit almost $150 a barrel just before the global financial crisis.
No one believes this short-term price surge — dubbed a “final hurrah” by some executives — will solve the problems facing the oil sector. Tightening climate policies will eventually overwhelm the industry, say its critics. But the next few years could still bring a bonanza for producers because years of misspending and a chronic lack of investment have left the industry unable to meet consumers’ post-pandemic thirst for oil. “We’ve all decided that we want to stop investing in oil supply,” says Ben Dell, head of Kimmeridge, a private equity investor. “But nobody told the consumer.”
Wil VanLoh, head of Quantum Energy Partners, one of the biggest oil-focused private equity firms in the US, says the world needs to be prepared for “triple-digit oil prices”. “It’s going to financially cripple western economies,” he says.
Analysts say the implications will be profound for global politics. Opec producers will reap the rewards of higher prices, but consumer governments’ anxieties over energy prices and the cost of renewables may also affect the pace of the energy transition.
Concern over soaring fossil fuel prices “will lead to a rethink of priorities and investment and timing,” says Daniel Yergin, vice-president of consultancy IHS Markit and author of The New Map, a book on global energy. “It puts energy security and reliability back on the same agenda as energy transition.”
In many big cities, car journeys are back above the pre-pandemic norm © Alex Wong/Getty Images
A year away from midterm elections, the danger of further oil price inflation for Biden is plain. A gallon of petrol in the US now costs on average $3.40, according to the AAA motoring group — half the price a consumer in the UK might pay, but 60 per cent more than during the final months of the presidency of Donald Trump. Stickers of a pointing Biden, declaring, “I did that”, are available on Amazon.com and have, in recent weeks, begun appearing next to the price ticker on forecourt pumps.
Biden’s Republican opponents have seized on rising petrol prices to argue that his energy policies are penalising Americans already squeezed by supply chain chaos. The president’s restrictions on new federal drilling licences and cancellation of the Keystone XL oil pipeline — one of his first acts in office — have brought an inevitable reckoning, they say.
Stickers of a pointing Joe Biden, declaring, ‘I did that’, have begun appearing next to the price ticker on forecourt pumps © Ty O’Neil/SOPA Images/LightRocket via Getty
In reality these market distortions have little to do with federal energy policy. They are mostly the result of a global oil industry responding to last year’s price crash, the near halving of upstream capital spending plans that followed supply disruption caused by hurricanes, and the sharp post-pandemic recovery that has ensued.
Sceptical capital markets, environmentally-minded shareholders, government regulation and a fundamental doubt about oil’s long-term future in a lower-carbon world are stopping investment, say oil market analysts. And it is happening even as demand roars back to life. Even now, as cash pours in, oil groups such as Shell and ExxonMobil — heeding the messages from the courts and activist investors — are using the money to buy back shares and raise dividends not to boost production.
“The oil industry is investing for net zero,” says Martijn Rats, chief commodity strategist at Morgan Stanley, referring to a report from the International Energy Agency that said the world had no more need for oil projects if it wanted to curb emissions in line with the Paris climate goals. “But our demand doesn’t look anything like net zero. A peak in supply is probably going to happen before a peak in demand.”
For some analysts, this emerging supply gap is similar to the conditions that created the oil bull run between 2005 and 2008, when crude hit its record price of $147 a barrel.
Goldman Sachs says the start of a multiyear “structural bull market” is now under way. But not all analysts agree. Fears of under-investment triggering supply shortages have been around for years without ever really coming true, says Bassam Fattouh, head of the Oxford Institute for Energy Studies. He expects that the current oil price surge could dissipate as early as next year.
But others say further price inflation may be necessary if supply and demand are to come back into balance. “The price is going to have to stay higher for a longer period of time in order to motivate some change in behaviour,” says Arjun Murti, a veteran energy analyst who forecast the oil price peak of 2008. “Whether that takes one or five years is unclear.”
The pandemic’s silver lining fades
As the air quality in cities improved last year, a seductive notion emerged: that pandemic lockdowns had helped cure the world of its oil addiction. Governments could now “build back better”, accelerating a clean green pivot to the lower-carbon economy and making strides in the effort to halt climate change.
The notion, at least in terms of demand, has proved shortlived. Stimulus spending and months of cheap oil prices sparked a revival in consumption at a pace almost as stunning as the drop had been during the pandemic collapse. Between the second quarters of 2020 and 2021, global oil consumption rose by 12m b/d, according to the IEA, an unprecedented surge.
BP now estimates that global consumption is already back to 100m b/d, close to 2019 levels. More consumption growth lies in wait, argue other analysts, as supply chain bottlenecks are loosened and jet fuel demand picks up once travel begins again in earnest.
US shale producers have barely responded to the crude market recovery © Daniel Acker/Bloomberg
In ordinary times, oil prices at more than $80 a barrel — about $30 above the long-term average price in real terms — would have already triggered considerable demand erosion. This time, however, there is little sign of consumers reacting to the higher price by cutting back, says Morgan Stanley’s Rats.
“We don’t know where the demand destruction price is,” he says. Nobody is reacting to higher oil prices as they might have done pre-pandemic, he adds. “I don’t think people are going to say, ‘I’ve not seen my client for two years. I’ve not been on holiday for two years . . . but I’m not going to fly because oil’s at $95 a barrel’.”
Global mobility trends bear out some of the recovery. Map direction requests from Apple, for example, suggest that while trips made on public transport have not reached their pre-pandemic level, in many big cities car journeys are back above the norm. Air travel is creeping higher. Demand for oil in the US in the past four weeks was just shy of 21m barrels a day, only 2 per cent less than for the same period two years ago.
These trends are vulnerable to any Covid flare up, Iran nuclear deal or economic slowdown. But other factors are also pushing demand higher, say analysts. Record high natural gas prices in Asia, for example, have prompted some industrial consumers to buy oil for generation instead. Goldman Sachs estimates this will add at least 1m barrels a day to global demand this winter — a huge extra pull.
The investment bank also believes that green infrastructure spending — which could soak up around $16tn of investment in the next decade — will spark more demand for commodities, from copper to diesel. Outright stimulus spending will boost energy consumption from low-income households.
“The whole idea of the war on climate change is to get rid of oil — but the investment in green capex today stimulates oil demand,” says Jeff Currie, the bank’s head of commodities research. “Between now and 2025, you’re really not going to make a dent on demand.” He predicts that for every $1tn of new stimulus spending, 200,000 b/d more of demand for oil is created — about as much as Portugal consumes each year.
Oil may be approaching its twilight years as the world shifts away from fossil fuels, Currie says, but coal and tobacco, two other “pariah commodities”, are now both enjoying bull runs, he adds.
Shale could come up short
The bigger market distortion is in supply — and nowhere is that more visible than in the US. On the surface, things suddenly look rosy. Oil company coffers are bursting with cash again. Last week, less than 24 hours after Darren Woods, ExxonMobil’s chief executive, and his Chevron counterpart Michael Wirth appeared in Congress for a grilling about climate disinformation, their companies reported bumper quarterly profits and juicy share buybacks.
Exxon, defeated by the activist hedge fund Engine No 1 in a bitter shareholder proxy battle earlier this year, even raised its dividend for the first time since before the pandemic. Shale companies are in similarly rude financial health.
It marks a big shift — all thanks to the oil price recovery engineered by the deep supply cuts made, under US pressure, by Saudi Arabia, Russia, and other members of the Opec+ group of producers last year. In April 2020, US oil prices crashed below zero for the first time. Last week, they sat at almost $85 a barrel.
Yet American shale producers, whose spectacular supply growth over the past decade made the country the world’s biggest producer, have barely responded to the crude market recovery. From a high of 13m b/d in November 2019 — almost 15 per cent of total world output — US output is expected to reach just 11.1m b/d in November.
One explanation is the arrival of an era of capital discipline in a shale patch that was notorious for an addiction to drilling that wasted creditors’ cash. Even now, as producers such as Pioneer Natural Resources and Diamondback Energy pay chunky dividends and report bumper cash flows, investors remain wary.
“Everybody’s going to be disciplined, regardless of whether it’s $75 Brent, $80 Brent, or $100 Brent,” Scott Sheffield, Pioneer’s boss, said recently. “All the shareholders that I’ve talked to say that if anybody goes back to [production] growth, they will punish those companies.”
The attitude could change in 2022 if oil prices remain high. Chevron and Exxon are already both running more rigs than last year in the Permian Basin of New Mexico and Texas. The US Energy Information Administration thinks production by December 2022 will have risen to 12.2m b/d, still well shy of its pre-pandemic highs. Other operators worry that when they decide to increase production again, a battered industry will take time to scale up and rehire all the workers fired last year.
Chevron and Exxon are both running more rigs than last year in the Permian Basin in Texas © Angus Mordant/Reuters
Pressure to ‘not invest’
The rest of the world may not have much new oil to yield either. From a peak of almost $1tn in upstream capital spending in 2014, the total had fallen to less than $400bn by 2020 and is forecast to remain below $500bn between now and 2025, according to Wood Mackenzie, a consultancy. And even though development costs have also fallen — reducing the amount of spending needed — the direction of travel is obvious.
“We’re in an environment now where there’s a lot of pressure on oil companies to not invest,” says Murti. “That pressure comes from investors. It comes from environmental and climate activists. It comes from government officials.”
It is also a product of companies’ own failures, says Charlie Penner, who led Engine No 1’s successful proxy war this year against Exxon. Even during periods of rapid oil demand growth in the past, big capital projects such as those in the Canadian oil sands have proved poor investments and dragged on the profits of the oil majors, he says. Splurging money on big developments now, when investors discount oil producers’ long-term value and worry about assets stranded by the energy transition, is even less rational, he says.
Air quality in cities improved last year during pandemic lockdowns © Paul Hanna/Bloomberg
Huge capital projects to increase total fossil fuel production in decades to come “don’t seem to make sense,” Penner says, “and the market is rewarding [Exxon and other producers] for diverting cash away from those types of projects and returning it to shareholders”.
In the very near term, it poses a dilemma for Opec. With shale producers unlikely to overwhelm the market any time soon, the group is now in control of prices. Biden’s request for more oil from Saudi Arabia and its partners confirms as much, say analysts.
But Amy Myers Jaffe, a professor at Tufts University’s Fletcher School, says Saudi Arabia should beware of taking that position for granted. Another price spike is the last thing anyone selling a fossil fuel should hope for.
“It’s never been the case that people look at the higher oil price and say ‘You know what? I want to be more dependent on Saudi Arabia, and Russia and Iran, so therefore I’m going to stop doing alternative energy,’” she says. “And there’s this belief this time around, that politicians will say that because there’ll be a backlash against renewable energy [that they will drop it]. It’s not going to happen.”