As the second anniversary of the pandemic approaches, the oil sector is in a far stronger position to weather the storm than it was. Prices continue to rise and several factors point to them staying relatively high for some time to come. Whether they will reach the levels that some analysts are suggesting remains to be seen, suggests Kay Rieck, an experienced market observer and investor.

It is no exaggeration to say that the oil sector is complex.

Having spent the last few years in the doldrums, it now seems like the industry is on top of the world. This time a year ago, there was the first hints of a renaissance, and some forecasters started talking, admittedly slightly hopefully, about oil achieving US$100 per barrel by the end of 2021.

While didn’t quite turn out that way, as we reach the turn into February, prices are holding their own at around US$85 per barrel, with the return of the global economy, coupled with supply issues and a concerning geopolitical situation all coming together to keep demand higher than supply.

Optimists are never satisfied though, and in the middle of January, one analyst started suggesting that we could see oil prices reach US$200 per barrel within the next five years. It’s a jaw dropping suggestion, but the analyst in question has some credibility and makes a good case for oil prices to keep climbing.

This blog has discussed the dangers of prognostication in the oil sector, but at this point it is worth having a look at some of the factors that could keep prices rising over the next few weeks, months and years.

Geo-political tension

Let’s start with the one at the top of the agenda at the moment. Irrespective of the rights and wrongs of the current situation in the Ukraine, oil prices have always risen when the geo-political tension has been ratcheted up. The impact tends to be short-lived, assuming that global powers can find a way to talk each other back from the brink, but there are always plenty of points of potential conflict around the world, and the markets don’t tend to react particularly to who the specific antagonists are, they react to whether the incident in question could lead to supply constrictions in the short- or medium-term.

Supply issues

As we have discussed a couple of times, while the Organization of the Petroleum Exporting Countries and affiliates (OPEC+) have increased oil production with a view to getting production back to pre-pandemic levels by September, several countries have reported that they are having difficulty meeting their production targets.

Much of this is the result underinvestment from even before the pandemic when oil prices had been struggling. It could be that production rates will start to recover as the relatively high price per barrel makes it worth investing, but given the focus that there has been on the environmental agenda over the last few years, it could be that some countries will avoid much beyond short-term commitments. If this proves to be the case, then there is a good chance that supply will continue to constrained and this would keep prices buoyant.

Managing inventories

The strategy of OPEC+ has been two-fold. On the one hand it has been trying to balance supply and demand so that the oil sector avoids its familiar boom and bust cycle. At the same time it has been trying to manage global inventories.

When the global economy was shut down in 2020, inventories began to build up. Oil producers were looking for places to store their oil and now they need to move these products out of storage and on to their end consumers. This takes an impressive level of discipline because with oil prices at their highest levels for five years, the temptation would be open the taps and get some cash into an industry that has suffered significantly during the pandemic.

Covid-19

Part of the reason that they have managed to maintain this discipline is the fear of fresh Covid-19 outbreaks.

While the omicron variant appears to have been less of a challenge than feared so far, it was a reminder that Covid is still a long way from metamorphosising from pandemic to endemic. While some suggest that that the Spanish Flu of the early 1920s came in three waves, becoming gradually less effective each time, nobody has yet been able to offer a valid medical reason why Covid will follow the same path. If the next variant or sub-variant proves to be concerning, the impact on the global economy could be significant.

In this situation, oil producers do not want to left with a collapse in the price of oil similar or worse than they faced at the start of 2020 when Brent Crude dipped to around US$20 per barrel. A a result, inventories are being managed very carefully.

Talk about the weather

One interesting point to make here is that while the end of the winter in the northern hemisphere may reduce the demand for oil as heating systems start to be turned down, there is a risk that rising global temperatures will drive more people into using air conditioning units for longer. As we saw in the summer of 2021, this could reduce the opportunity for countries to replace their reserves during the summer months, keeping pressure on demand.

Adding to this, with some uncertainty about global travel continuing, this summer in the northern hemisphere is likely to mean continued high demand for gasoline for drivers that are staying in their immediate neighbourhood rather than getting on a plane to get to sunnier parts. Whether this is balanced out by lower demand for jet fuel is unknown at this point.

Demand issues

They say that the price of oil rises like a rocket and falls like a feather. Given that the oil price rises at the end of 2021 were initially driven by several short-term factors such as the shutting down of production in the Gulf of Mexico following the damage caused by Hurricane Ida, it may be that as we reach the second quarter of 2022, prices will start to subside a bit because these short-term factors will no longer be in play.

Energy transition

As the headlines showed last year, we are in a period of energy transition with many governments around the world trying to work out how to decarbonise their economies. In the short term this means less investment in the oil and gas sector, which in turn means that capacity will stay relatively static and prices will be very sensitive to demand increases.

The markets

While there is probably no such thing as a true free market, the global oil sector is a fairly good example of an effective market. When there is a shortage, prices rise to the point where capacity that was previously too expensive to bring to market becomes viable. From the perspective of the oil industry, there is plenty of available oil that will come onto the market when the price reaches a certain threshold.

The challenge is that this kind of oil takes time to bring to market, so you need to be certain that prices are going to remain at the viable level for some time before committing to investing. Each field has a different point of viability, so they are likely to be coming on stream at different points as prices rise.

In short, the price of oil and gas is subject to a range of factors that interplay with different emphasis throughout the year. Pronouncements about the potential for oil to reach US$200 per barrel are an interesting way to attract headlines, but the reality is that it is very difficult to say what is going to happen in the long term because of the interplay for factors.

While US$200 per barrel may remain a fantasy in the short to medium term, there are plenty of factors that are likely to keep oil prices buoyant. The bottom line is that the oil sector will continue to play an important role in the global economy and be a fascinating place to do business for many years to come.

Kay-Rieck

About the Author

Kay Rieck has been an investor in the US oil and gas sector for more than two decades. He was a financial advisor and stockbroker on the New York Stock Exchange (NYSE) for many years.

He quickly developed his interest in the oil and gas sector and related assets, building his expertise in investment banking and asset management at the New York Board of Trade and the Chicago Board of Trade.

Leveraging his exceptional network of global contacts, he founded his first oil and gas development company in the U.S. in 2008, selecting investments in the Haynesville Shale, Permian Basin, Eagle Ford Shale, Dimmit County, and anywhere else that offered and continues to offer exceptional return prospects.