Why are oil prices so high? Will they hit US$100 a barrel?

Tanker trucks drive down a road near an oil refinery in El Paso, Texas on Dec 10, 2021. PHOTO: AFP

HOUSTON (NYTIMES) - Oil prices are soaring again, casting a shadow over the economy, driving up inflation and eroding consumer confidence.

Crude prices rose more than 15 per cent in January alone, with the global benchmark price crossing US$90 a barrel for the first time in more than seven years, as fears of a Russian invasion of Ukraine grew.

Many energy analysts predict that oil could soon touch US$100 a barrel, even as electric cars become more popular and the Covid-19 pandemic persists. Exxon Mobil and other oil companies that only a year ago were considered endangered dinosaurs by some Wall Street analysts are thriving, raking in their biggest profits in years.

Why are oil prices suddenly so high?

The pandemic depressed energy prices in 2020, even sending the United States benchmark oil price below zero for the first time. But prices have snapped back faster and more than many analysts had expected in large part because supply has not kept up with demand.

Western oil companies, partly under pressure from investors and environmental activists, are drilling fewer wells than they did before the pandemic to restrain the increase in supply. Industry executives say they are trying not to make the same mistake they made in the past when they pumped too much oil when prices were high, leading to a collapse in prices.

Elsewhere, in countries like Ecuador, Kazakhstan and Libya, natural disasters and political turbulence have curbed output in recent months.

On the demand side, much of the world is learning to cope with the pandemic and people are eager to shop and make other trips. Wary of coming in contact with an infectious virus, many are choosing to drive rather than taking public transportation.

Tensions and turbulence in places like Kazakhstan and Ukraine are factors tha thave driven up oil prices. PHOTO: AFP

But the most immediate and critical factor is geopolitical.

A potential Russian invasion of Ukraine has "the oil market on edge", said energy analyst Ben Cahill, a senior fellow at the Centre for Strategic and International Studies in Washington. "In a tight market, any significant disruptions could send prices well above US$100 per barrel," Mr Cahill wrote in a report this week.

Russia produces 10 million barrels of oil a day, or roughly one of every 10 barrels used around the world on any given day. Americans would not be directly hurt in a significant way if Russian exports stopped, because the country sends only about 700,000 barrels a day to the US. That relatively modest amount could easily be replaced with oil from Canada and other countries.

But any interruption of Russian shipments that transit through Ukraine, or the sabotage of other pipelines in northern Europe, would cripple much of the continent and distort the global energy supply chain. That is because, traders say, the rest of the world does not have the spare capacity to replace Russian oil.

Even if Russian oil shipments are not interrupted, the US and its allies could impose sanctions or export controls on Russian companies, limiting their access to equipment, which could gradually reduce production in that country.

In addition, interruptions of Russian natural gas exports to Europe could force some utilities to produce more electricity by burning oil rather than gas. That would raise demand and prices worldwide.

What can the US and its allies do if Russian production is disrupted?

The US, Japan, European countries and even China could release more crude from their strategic reserves. Such moves could help, especially if a crisis is short-lived. But the reserves would not be nearly enough if Russian oil supplies were interrupted for months or years.

Western oil companies that have pledged not to produce too much oil would most likely change their approach if Russia was unable or unwilling to supply as much oil as it did. They would have big financial incentives - from a surging oil price - to drill more wells. That said, it would take those businesses months to ramp up production.

Countries could release more crude from their strategic reserves to help. PHOTO: NYTIMES

What is Opec doing?

US President Joe Biden has been urging the Organisation of the Petroleum Exporting Countries (Opec) to pump more oil, but several members have been falling short of their monthly production quotas, and some may not have the capacity to quickly increase output. Opec members and their allies, Russia among them, agreed on Wednesday (Feb 2) to stick to a plan for increasing production next month by a relatively modest 400,000 barrels a day.

In addition, if Russian supplies are suddenly reduced, Washington is likely to put pressure on Saudi Arabia to raise production independently of the cartel. Analysts think that the kingdom has several million barrels of spare capacity that it could tap in a crisis.

What would it take for oil prices to fall?

Oil prices go up and down in cycles, and there are several reasons prices could fall in the next few months. The pandemic is far from over, and China has shut down several cities to stop the spread of the virus, slowing its economy and demand for energy. Russia and the West could reach an agreement - formal or tacit - that forestalls a full-scale invasion of Ukraine.

High prices could depress demand for oil enough that prices begin to come down. PHOTO: REUTERS

And the US and its allies could restore a 2015 nuclear agreement with Iran that former president Donald Trump abandoned. Such a deal would allow Iran to sell oil much more easily than now. Analysts think the country could export one million or more barrels daily if the nuclear deal is revived.

Ultimately, high prices could depress demand for oil enough that prices begin to come down. One of the main financial incentives for buying electric cars, for example, is that electricity tends to be cheaper per mile than petrol. Sales of electric cars are growing fast in Europe and China and increasingly also in the US.

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