Are We on the Verge of an Oil Price Recovery?

 


INSIGHT


  • MARKET CHANGES: THERE IS A GENERAL TENDENCY TO ATTRIBUTE THE OIL PRICE DECLINE IN EARLY 2020 TO THE CORONAVIRUS PANDEMIC. BUT MACROECONOMIC DEVELOPMENTS AND TRENDS SUGGEST THAT THE ECONOMY HAS ALREADY DETERIORATED IN THE 4TH QUARTER OF 2019. 
  • A MAJOR SLUMP WAS INEVITABLE, BECAUSE SINCE THE FINANCIAL CRISIS OF 2008 WE HAVE SEEN A MAJOR SURGE IN GLOBAL INDUSTRIAL PRODUCTION. CHINESE DEMAND IS NO LONGER GROWING BY LEAPS AND BOUNDS. 


1. The first signs of a major recession and a decline in oil prices began in Q4 2019


We have seen the price of oil drop dramatically from April 2020, partly related to the coronavirus crisis that has begun to affect the macroeconomy. But that is only part of the story. Let’s not forget that because of the coronavirus, demand for crude oil, more specifically refined oil, dropped even more significantly in the run-up to April 2020. Demand actually fell first. After demand dropped, we saw oil dumped on the market.


Let’s take a look at the oil price. What trends can we deduce?


2. Storage capacity in the U.S. helped us reduce the impact of market disruption


The oil storage facilities were full and there was no more room for the remaining volumes. We also have to keep an eye on logistics, especially the mid-stream business. A great many tankers were already on their way from the Gulf region to Europe and from the Gulf region to East Asia. It can take weeks before the final destination is reached and the volumes can be unloaded at the port. While the price of oil was at a certain level when these tankers left port in the Gulf region, the price fell during the time they were crossing the ocean. So as prices fell faster, everyone scrambled to find storage capacity.

The United States was fortunate in some ways because it has significant storage capacity that allows it to manage oil supplies very effectively. This was also because the United States was an exporter of hydrocarbons for the second time in its history. With more oil flowing out of the United States than coming in, oil traders had a little more time to find adequate storage. What strikes the observer is that it has taken this long for oil prices to show signs of recovery. This likely reflects the macroeconomic weakness we are seeing in most parts of our economy right now. 


3. The pandemic has had a strong impact on the oil price


In order to predict the price of oil, we also need to keep an eye on the coronavirus and the associated closures. Because many workers no longer drive to work, the economy is deprived of a significant amount of transportation fuel that would otherwise be needed to meet our energy needs. The fact that people are spending more time at home and have been working from home for more than a year has caused entire supply chains to reorganize. As a result of the coronavirus pandemic, these supply chains have become more efficient and fuel-efficient as more and more of the economic activity has moved to the digital realm. 

This brings us to another important factor that is often underestimated in the discussion about the oil price. By this we mean the increasing digitalization of our economy, which reduces oil consumption in the public and private sectors. Because not only do people go to the office less often, they also go to the hospital less often, they don’t drive to restaurants, and they certainly try to avoid international travel where they can. 


4. Peak oil is always lurking in the background and plays a major role in setting oil prices


Lurking in the background is the great unknown we might call peak oil. Although peak oil is a long-term trend in the oil industry, it affects oil markets quite significantly over the years. We are slowly using up all the conventional, easy-to-find oil and what is left is the hard-to-find crude oil. This oil tends to be more expensive and is much more costly to process. Over time, this will continue to drive up the price of oil and could be one of the reasons why we are seeing a gradual recovery in the price of oil. 


5. Saudi Arabia played a significant role as an oil supplier of last resort


On the other hand, one could also argue against this and simply say that countries like Saudi Arabia have cut their oil supply. That has certainly had an impact on international oil markets. And yes, most critics would generally agree that Saudi Arabia has taken advantage of its position as an oil supplier of last resort, because Saudi Arabia also has the oil that is easy to work with. 


6. Conclusion


The general trend is that oil prices may experience a gradual recovery, although it is very difficult to predict how long the increase will last. As refineries gradually feed off stored oil stocks, the remaining oil available on the market will shrink. This is likely to have a medium-term impact on oil prices. It really depends on how long the second lockdown lasts, people’s confidence in the economy, and health and safety. Given the fact that people have saved a lot of money since the recession began, we could well see a rebound in aviation as people travel more. This will also drive up demand for oil and especially jet fuel. 


7. References:


U.S. Energy Information Administration, Average monthly U.S. refiner acqusition cost of crude oil, 1985 – 2020, Petroleum Marketing Monthly, February 2021, Available at: Oil prices and outlook – U.S. Energy Information Administration (EIA).


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This article is just meant to inform the reader of recent developments in the energy industry at large and to share knowledge and insights with a wider audience. The author does not put forth investment recommendations. This article should not be taken as investment advice and the author cannot be held to account for investments made. For more information, please refer to the Legal Disclosure and Privacy Policy, which you can click on or find at the top of this page in the menu bar. 

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