Oil prices have been on a bullish trend since the start of the year, reaching their highest levels since 2014. The main drivers behind the rally are the strong recovery in global oil demand, the tight supply from OPEC+ and other producers, and the rising geopolitical tensions in the Middle East and elsewhere. In this article, we will examine the factors that are influencing the oil market and the outlook for the future.
Global Oil Demand Rebounds from Pandemic Slump
One of the key factors that has boosted oil prices is the rebound in global oil demand, which was severely hit by the Covid-19 pandemic last year. According to the International Energy Agency (IEA), global oil demand is expected to grow by 5.4 million barrels per day (bpd) in 2024, reaching 96.4 million bpd, after falling by 8.7 million bpd in 2020. The demand recovery is driven by the easing of lockdowns, the rollout of vaccines, and the fiscal stimulus in major economies.
The IEA also noted that the demand growth is uneven across regions and sectors, with China and the US leading the recovery, while Europe and India lagging behind. The demand for gasoline and diesel has recovered faster than that for jet fuel, as air travel remains subdued. The IEA also warned that the demand outlook is subject to uncertainty, as the pandemic situation and the pace of vaccination vary across countries.
OPEC+ and Other Producers Keep Supply in Check
Another factor that has supported oil prices is the tight supply from OPEC+ and other producers, who have been implementing output cuts since last year to balance the market and prevent a price collapse. OPEC+, which consists of the Organization of the Petroleum Exporting Countries (OPEC) and its allies led by Russia, agreed in December to gradually increase production by 2 million bpd from January to April, after cutting output by 9.7 million bpd in 2020. The group also decided to extend the duration of the output deal until the end of 2024, and to meet monthly to review the market conditions and adjust the production levels accordingly.
The OPEC+ output policy has been effective in reducing the global oil inventories, which had accumulated during the pandemic. According to the IEA, the OECD commercial oil stocks fell by 50.8 million barrels in November, reaching 163.1 million barrels above the 2015-2019 average, down from a peak of 249 million barrels in July. The IEA also estimated that the global oil market was in a deficit of 1.3 million bpd in the fourth quarter of 2020, and will remain in a deficit of 0.7 million bpd in the first quarter of 2024.
However, the OPEC+ output policy is not without challenges, as some members have been struggling to comply with their quotas, while others have been seeking to increase their market share. For instance, Iraq, Nigeria, and the United Arab Emirates (UAE) have been overproducing in recent months, while Saudi Arabia, the de facto leader of OPEC, has been voluntarily cutting an extra 1 million bpd since February to compensate for the non-compliance of others. Moreover, Iran, which is exempt from the OPEC+ deal due to the US sanctions, has been ramping up its oil exports in anticipation of a possible return to the 2015 nuclear deal under the new US administration.
In addition to OPEC+, other oil producers have also been keeping their supply in check, either voluntarily or involuntarily. For example, the US shale oil production, which was the main source of supply growth in the past decade, has been declining since the pandemic, as low oil prices and financial constraints have forced many shale companies to cut their spending and drilling activity. According to the US Energy Information Administration (EIA), the US crude oil production averaged 11.3 million bpd in 2020, down from a record high of 12.2 million bpd in 2019, and is expected to average 11.1 million bpd in 2024.
On the other hand, some oil producers have been facing involuntary supply disruptions due to political instability, civil unrest, or technical issues. For example, Libya, which is also exempt from the OPEC+ deal, has seen its oil production fluctuate between 100,000 bpd and 1.2 million bpd in the past year, depending on the security situation and the negotiations between the rival factions in the country. Similarly, Venezuela, which is under US sanctions and suffering from an economic crisis, has seen its oil production drop to less than 500,000 bpd, down from over 2 million bpd in 2018.
Geopolitical Tensions Add Risk Premium to Oil Prices
A third factor that has contributed to the rise in oil prices is the increasing geopolitical tensions in the Middle East and other regions, which pose a risk to the oil supply and demand. The Middle East is home to some of the world’s largest oil producers and exporters, such as Saudi Arabia, Iran, Iraq, Kuwait, and the UAE, and also hosts some of the most important oil transit routes, such as the Strait of Hormuz, the Suez Canal, and the Bab el-Mandeb Strait. Any disruption or conflict in the region could have a significant impact on the global oil market and prices.
One of the main sources of tension in the region is the ongoing rivalry between Saudi Arabia and Iran, which are backing different sides in the conflicts in Yemen, Syria, Iraq, and Lebanon. The tension escalated in January 2020, when the US assassinated Iran’s top general Qassem Soleimani in Iraq, prompting Iran to retaliate by launching missile attacks on US bases in Iraq and accidentally shooting down a Ukrainian passenger plane near Tehran. The tension eased slightly after the US and Iran agreed to resume talks on the nuclear deal in April 2024, but the prospects of a breakthrough remain uncertain, as both sides have set preconditions and demands for the negotiations.
Another source of tension in the region is the ongoing war in Yemen, where the Iran-backed Houthi rebels have been fighting against the Saudi-led coalition that supports the internationally recognized government. The war has caused a humanitarian crisis in Yemen, and also threatened the security of Saudi Arabia and the Red Sea shipping lanes. The Houthis have been launching frequent attacks on Saudi oil facilities and airports, as well as targeting oil tankers and vessels in the Red Sea. The most recent attack occurred on January 25, when the Houthis claimed to have hit a Saudi oil facility in Jeddah with a drone.
Other sources of tension in the region include the unresolved dispute between Qatar and its Arab neighbors, the political instability in Iraq and Lebanon, the civil war in Syria, and the normalization of ties between Israel and some Arab states. All these factors add a risk premium to the oil prices, as they increase the uncertainty and volatility in the oil market.
Outlook for the Future
The outlook for the oil market and prices depends on the interplay of the demand, supply, and geopolitical factors discussed above, as well as the potential emergence of new factors, such as the development of alternative energy sources, the adoption of climate policies, and the evolution of consumer behavior. Based on the current trends and projections, we can expect the following scenarios for the future:
- Bullish scenario: In this scenario, the global oil demand continues to recover strongly, as the pandemic is brought under control, the vaccination is accelerated, and the economic activity is boosted by the stimulus measures. The oil supply remains tight, as OPEC+ and other producers maintain their output discipline, and the US shale production does not rebound significantly. The geopolitical tensions in the Middle East and elsewhere escalate, leading to more attacks and disruptions on the oil infrastructure and transit routes. The oil prices surge to over $100 per barrel, reaching levels not seen since 2014.
- Bearish scenario: In this scenario, the global oil demand stalls or declines, as the pandemic worsens, the vaccination is delayed, and the economic recovery is hampered by the debt and inflation pressures. The oil supply increases, as OPEC+ and other producers relax their output cuts, and the US shale production recovers. The geopolitical tensions in the Middle East and elsewhere ease, leading to more stability and cooperation in the region. The oil prices drop to below $50 per barrel, reaching levels not seen since 2020.
- Neutral scenario: In this scenario, the global oil demand grows moderately, as the pandemic situation and the economic recovery vary across regions and sectors. The oil supply balances the demand, as OPEC+ and other producers adjust their output levels according to the market conditions. The geopolitical tensions in the Middle East and elsewhere remain at the current levels, leading to occasional attacks and disruptions, but no major conflicts or crises. The oil prices fluctuate between $70 and $90 per barrel, reflecting the supply and demand dynamics and the risk premium.
