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The sun sets behind a crude oil pump jack on a drill pad in the Permian Basin in Loving County, Texas, on November 24, 2019. Photo: Reuters
Opinion
Macroscope
by Neal Kimberley
Macroscope
by Neal Kimberley

How lagging production will push recovery-driven oil prices even higher

  • With global oil production increases trailing resurgent worldwide demand, not even China can expect to have much influence over prices
  • The global demand and supply mismatch and fears over rising inflationary pressures could drive oil prices even higher in the second half of 2021
Global demand for crude oil is surging as economies start to rebound from the Covid-19 pandemic. The oil price has risen as a consequence, but with a fundamental mismatch between demand and supply that looks likely to remain for some time, the oil price could well head higher still.
Policymakers in Beijing have already unveiled measures to try to stabilise some rising industrial metal prices through measured releases from China’s stockpiles of aluminium, copper and zinc. Given China’s appetite for and reliance on imported energy, they will surely also be watching the price of crude closely. 

But watching the oil price might be the most Beijing should do. With global oil production increases lagging behind resurgent post-pandemic worldwide demand for crude, not even an economic giant like China can expect to have too much influence over the oil price.

In fact, the stage looks set for even higher oil prices in the second half of 2021. 

Last week, data from the US Energy Information Administration showed that crude inventories in the United States fell by 7.4 million barrels in the week to June 11, triggering a rise in the oil price. The larger-than-expected inventory drawdown was interpreted by markets as just the latest sign of improving global demand for oil.

Meanwhile, even as worldwide demand for oil increases, suppliers are taking a measured approach to increasing production.

On June 2, the Organization of Petroleum Exporting Countries and other producers led by Russia rubber-stamped an earlier decision to increase output by 700,000 barrels per day (bpd) in June and 840,000 bpd in July. That, while welcome, is not enough to match the increase in demand.

In the US, as Reuters energy analyst John Kemp pointed out last week, “ US shale producers have so far reacted cautiously to the rise in prices, returning earnings to shareholders and cutting debt rather than increasing drilling and production.”
Who can blame them? With governments around the world rolling out policies to address climate change and drive the transition away from traditional energy sources such as crude and towards renewables, private sector oil producers might need some persuading that investing in new production makes economic sense from a longer-term perspective.

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China builds colossal horizontal onshore well in Gansu province

China builds colossal horizontal onshore well in Gansu province
No private sector oil producer will want to pour capital into new projects only to end up stuck with “stranded” energy assets. Even though the Permian Basin is the top-producing US shale basin, Royal Dutch Shell is reportedly considering an exit from its assets there, possibly as part of a wider move to cut its carbon emissions after a recent Dutch court ruling that it should accelerate its plans to do so.

With rising crude prices deriving from this ongoing global oil demand and supply mismatch, it is hard to see how any single country, even China, could do much to affect the situation.

Then there is the added dimension of market psychology around the oil price when there are broader concerns about rising inflationary pressures. US consumer prices rose 5 per cent year on year in May, the largest annual increase in almost 13 years.
The Federal Reserve might still be sticking to its view that US inflation pressures are “transitory”, but last week’s Fed policy statement was seen by markets as somewhat more hawkish. Fed chair Jerome Powell did acknowledge “the possibility that inflation could turn out to be higher and more persistent than we expect”. 

Runaway inflation? It’s still too early to make that conclusion

That possibility could feed speculative demand for oil. “With inflation apprehensions on the rise, investors are seeking protection,” Ehsan Khoman, the Dubai-based head of emerging market research at Japan’s MUFG Bank, wrote on June 17. “Throughout history, oil has proven to be much more correlated with inflation rates than financial assets.” 

As oil is an “anchored asset which only depends on the prevailing level of demand and supply”, Khoman argued, it “therefore is an attractive asset class to protect against short-term unanticipated inflation that is created in response to a rapidly expanding global economy”.

In short, rising global demand for oil that is unmatched by an accompanying rise in supply inevitably pushes up the price of crude. If markets then fear that this phenomenon could trigger future inflation that is not currently anticipated and so not priced in, as now appears to be the case, markets end up buying yet more oil as a form of protection against such a perceived outcome.

All in all, the oil price looks set to go even higher.

Neal Kimberley is a commentator on macroeconomics and financial markets

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