LONDON: Oil prices have increased above the long-term average after accounting for inflation, and if they continue to rise, consumers will become increasingly resentful. Brent futures are currently trading about US$75 per barrel, up from an inflation-adjusted median of slightly over US$70 since the turn of the century.
Bullish long bets outnumber bearish short positions in crude by a 6:1 ratio, indicating that hedge funds and other money managers believe prices will increase further.
Prices are expected to surpass US$80 this summer, according to Goldman Sachs, as the deployment of coronavirus vaccines allows more businesses to operate and travel to resume.
Nonetheless, the Organization of Petroleum Exporting Countries and its Allies (OPEC+) and US shale producers are carefully raising output.
“I’m still convinced the producers will not respond,” Scott Sheffield, chief executive of Pioneer Natural Resources, one of the top shale producers, said. In an interview with Reuters, he noted that a focus on shareholder returns has kept spending modest.
“Oil prices are likely to break US$80 per barrel here soon, and I don’t see any rig additions,” Sheffield added.
However, if prices continue to rise to US$80 or more, governments, corporations, and motorists in the key consuming countries are likely to react more strongly.
Brent has been below US$80-88 per barrel in real terms for 60-67 percent of the time since 2000, therefore prices over this level are likely to be perceived as exorbitant by consumers in compared to prior experience.
Oil prices will begin to become politically sensitive anywhere between $75 and $85 and will have an impact on consumer behavior and petroleum use.
High costs, in particular, will drive a greater focus on lowering petroleum-based fuel consumption and hastening the transition to alternatives such as electric vehicles.
RESPONSE TO QUESTIONS ABOUT PRICES
The US Congress mandated a large increase in the volume of ethanol mixed into the fuel supply to cut expensive petroleum usage in the Energy Policy Act in 2005, when prices climbed beyond US$80 in real terms.
With actual prices back above US$80 in 2007, Congress enacted the Energy Independence and Security Act, which tightened car fuel economy standards to reduce petroleum usage.
When prices were significantly higher than US$80 in the last two decades, U.S. businesses and motorists chose smaller, lighter, and more fuel-efficient vehicles to cut operating costs.
With hybrid and full-electric vehicles becoming more widely available in the United States and Europe for the first time, a substantial increase in the price of oil is likely to hasten their adoption and cut petroleum usage.
High prices are also likely to attract negative attention from politicians and regulators, particularly in the United States, who are concerned about oil market competitiveness.
Increased interest from US legislators in withdrawing OPEC of its sovereign antitrust immunity has been linked to real prices above US$80.
When nominal prices rose above US$75 under the Trump presidency, the White House pressured OPEC for more output.
The Biden administration is unlikely to engage in public oil diplomacy via Twitter, but it will be aware of the impact of high and growing costs on swing voters, and may exert discreet informal pressure.
“While global forces shape oil prices, the President understands that gas prices are a source of pain for Americans, particularly the middle-class families he has prioritized in his economic agenda,” the White House said in a statement at the end of May, after gasoline prices rose as a result of the Colonial pipeline disruption.
CONSUMPTION LOST
Oil price responses by policymakers and consumers are non-linear. The larger the response from policymakers and users, the higher prices increase and the longer they are projected to remain high. At US$75, policy and consumer reactions are likely to be moderate, but noteworthy if Brent rises to US$85, and very important if Brent rises to US$95. In most circumstances, once consumption has been lost during a period of high costs, it does not recover unless prices fall below the long-term average for a lengthy period. With a delay of at least 12-36 months, policy and consumer responses have a substantial impact on oil demand and consumption (in some cases much longer). The threat of more conservation and moving to non-petroleum substitutes will not necessarily prevent prices going exceeding US$80 or even higher in the next 12-24 months due to the delays required. However, as consumers seek cheaper fuel prices and more energy security, it is likely that the transition to alternatives will speed in the medium and long term. It will be difficult to reverse by the time the impact on consumption is visible in published figures, and it will contribute to the next oil price drop. A short price surge may be welcomed by climate activists and proponents of electric vehicles, as it will reinforce their cause for a faster shift to zero-emission vehicles. Significantly higher prices in the short term, however, are likely to lead to an accelerated loss of demand by the second half of the decade for OPEC+, US shale producers, and the rest of the oil sector. Oil producers must measure the short-term income benefits from a price spike against the long-term revenue losses from an accelerated decline in oil use when planning their approach./nRead More