Why Is The Price Of Oil Rising?

Why Is The Price Of Oil Rising?
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Just when America’s drivers thought the worst of the summer gasoline price spike was in the rearview mirror, geopolitics strikes back.

A gallon of gas costs $3.80 today, virtually unchanged from the past month. Gas prices are well off their all-time record highs above $5 a gallon from earlier this summer. Just be warned that the pump price may be inching up soon.

New reports suggest that at a meeting later this week, OPEC+ will agree to reduce oil production by more than 1 million barrels a day, the first proposed target reduction since the Covid-19 pandemic. Why now? The organization is likely looking to raise oil prices in the face of slowing global economic growth.

The potential move comes as OPEC+ is already producing less than its target amount. A barrel of WTI crude oil was up 5% to more than $83 in the hours after the news broke.

“The group’s decision to assemble in-person for the first time since 2020 at this week’s meeting suggests that we’ll see a material policy announcement,” said Noah Barrett, research analyst for energy & utilities at Janus Henderson Investors. “As a group, OPEC+ is currently underproducing its collective quota, so if we see a headline cut of 1 million barrels per day, the actual impact on supply will be around 500,000. However, a supply reduction of 500,000 is still material in this market.”

A production cut by OPEC and its Russian ally would be another hit to global energy consumers, piled atop the sanctions imposed on Moscow by many western countries after Russia’s unprovoked invasion of Ukraine.

Where will oil prices go now? The answer is complicated by conflicting narratives pointing in opposing directions.

OPEC Production Cuts Mean Higher Oil Prices

One of President Joe Biden’s principal foreign policy endeavors has been to convince Saudi Arabia and the rest of OPEC to increase their oil production.

“The idea that Russia and Saudi Arabia and other major producers are not going to pump more oil so people can have gasoline to get to and from work, for example, is not right,” Biden said at a G-20 meeting in November 2021.

Last last year, inflation had been high for six months, and the promise of a “transitory” inflationary period was fading away.

Biden made another appeal directly to Saudi officials during a trip to the gulf state in July 2022. At the time, drivers were getting crushed at the pump, and a barrel of oil was going for about $100 a barrel.

Since then, the price of oil has drifted downward, but not because Saudi Arabia decided to pump more oil. Instead, economies around the globe are weakening:

  • Expectations for China’s gross domestic product (GDP) have halved, as the world’s second largest economy has struggled with stringent, and ill-fated, lockdown policies meant to sniff out all Covid cases.
  • European nations are dealing with their own sky-high inflation, as well as a burgeoning energy crisis due to their reliance on Russian natural gas.
  • The United States has suffered through two successive quarters of negative economic growth, and the Federal Reserve is determined to increase interest rates for as long as it takes to bring inflation down, which will ultimately cause the economy to weaken further.

The price of oil is viewed through the lens of future global economic growth: Higher prices can signal investor belief that consumers will spend more, while falling prices demonstrate a conviction that demand will reduce.

The decision by OPEC+ is meant to help boost the cost of oil given the weakening demand, and comes after OPEC+ decided to modestly cut production in early September.

The Russo-Ukrainian War Goes On

While Saudi Arabia is the world’s second largest producer of oil, Russia is in third place.

That reality was thrown into stark relief after Russia invaded Ukraine in late February, causing crude oil prices to briefly rise above $100 a barrel, before ultimately touching $120 a barrel a few months later as the U.S. and its western allies imposed crippling sanctions on Russia.

Energy giants such as Shell, BP and Exxon all pulled out of Russian energy deals, while the Biden administration has announced a ban on importing Russian oil and other petroleum products, which represents about 8% of U.S.-bound crude shipments.

But Russia has not stood idly by, instead locating new buyers, especially in Asia and even the Middle East, for one of its most important exports.

“To date, Russian export flows have been resilient,” said Barrett. “Russia may have to sell its oil at a material discount, but the oil is still finding its way into global supply.”

Fresh European trade restrictions are scheduled to go into effect this winter. If they are successfully implemented, this could result in less supply on the market, and therefore higher prices. More expensive energy coming as temperatures drop in Europe could further aggregate already simmering geopolitical tensions.

The escalation of the war, including the mysterious sabotaging of the Nord Stream pipelines, Russia annexing four Ukrainian provinces and the threat of nuclear warfare will only further put tension on energy production that hundreds of millions of people depend on to live their lives.

U.S Oil Production Has Been Slow to Respond

Given all the geopolitical uncertainty, U.S. oil companies aren’t in a hurry to dramatically expand production. For instance, the U.S. produced 11.5 million barrels of crude oil a day in May 2022, according to the U.S. Energy Information Agency. While that’s 200,000 more than a year ago, it’s roughly half a million barrels a day less than in 2019.

Why? For one thing, major oil companies don’t want to invest heavily on new wells only to see supply increase, prices decline and their profits dwindle.

This was a major theme of the fracking boom that helped propel the U.S. to become the number one global oil-producing nation over the last decade and a half. Many companies went bankrupt as they overextended themselves building out infrastructure, only to see oil and gas prices plummet on greater and greater supply.

Meanwhile, there’s a large push by some of the world’s largest institutional investors, including BlackRock, to steer investment toward companies with low levels of environmental, social and governance (ESG) risk. That’s moved money away from oil and gas producers when those dollars would help increase production.

“Underinvestment because of ESG is one of the confluence of issues causing the price to increase,” Jack McIntyre, a portfolio manager at Brandywine Global, said.

Meanwhile, the Biden administration has paused new oil and gas leases on Federal land. That may not have an immediate impact on prices, but does affect supply in the years to come.

“My view is that an OPEC+ cut in the 1 million barrels per day range or higher will keep prices flat-to-higher from current levels, with a risk that we return to triple-digit prices if we see signs of global demand improving–particularly in –and/or a meaningful reduction in Russian supply as embargoes kick in,” said Barrett.

That is, until the next development occurs.

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