Oil prices continue to surge … the factors that are likely to keep it elevated … looking at how the Russian situation could resolve, and the implications for oil

 

Yesterday, oil briefly topped $115 a barrel – that’s the highest price since 2008.

As you can see below, West Texas Intermediate Crude (WTIC) has been on a tear since December.

Usually, you’d see this a chart like this and think “the profits are juiced. Too late to buy.”

That’s fair. In fact, our macro expert Eric Fry just recommended his Speculator subscribers close out a portion of their oil trade for a gain of 100%.

But while oil’s price is certainly vulnerable to a significant pullback if there’s any sign of a ceasefire, Eric thinks there are more gains to come, regardless of what tomorrow could bring.

That’s why he recommended his subscribers hold the other half of their oil trade.

So, let’s look at the factors that are likely to keep oil grinding higher, despite today’s elevated prices.

***The longer-term case for oil

Let’s begin by looking longer-term.

Momentarily forgetting Russian aggression, what’s the case for oil’s price to continue climbing over the coming years? Specifically, in light of the global push away from fossil fuels toward electric vehicles (EVs) and green energy?

Here’s Eric:

“What about EVs?” you say. “Won’t they cause crude demand to drop?”

The answer is yes… but not tomorrow.

Currently, more than half of every barrel of crude oil becomes fuel for an internal combustion vehicle. So it makes sense that EVs would reduce net demand for crude… but that day is not likely to arrive any time soon.

Even though EVs will capture a growing share of the global auto market, the total auto market will continue to grow larger. That means the number of gas-powered automobiles on the road will continue to increase for several more years.

The U.S. Energy Information Administration says the total number of internal combustion vehicles on the world’s roads will not peak until 2038.

Meanwhile, because crude demand from other end users will continue growing past that date, the International Energy Agency (IEA) expects worldwide oil demand to be at least 25% higher in 2050 than it is today.

In other words, most conventional oil-consuming technologies will die a slow death, no matter how rapidly EVs conquer the personal transportation industry.

So, let’s pull back our time frame now.

What about the next year or two? What factors will keep oil’s price elevated?

***The current imbalance in supply and demand won’t be fixed immediately

Even without the Russia/Ukraine conflict, the oil market has been struggling with its supply/demand equilibrium.

Much of the problem comes from several years of underinvestment in new oil projects.

Back to Eric on this:

Because so many oil companies around the world have slashed investment in both exploration and production, they cannot boost supplies… no matter how high the oil price soars.

As I’ve pointed out previously, data from Rystad Energy shows that global investments in oil and gas exploration and production peaked eight years ago and has plummeted about 65% since then.

Source: Rystad Energy

That’s no way to boost production!

Even though Rystad expects oil-industry investment to increase slightly this year, those efforts will be too little too late to impact near-term supplies. In all likelihood, the supply picture will not improve until after multiple years of increasing investment.

Therefore, the only factor that could “rescue” the oil market and halt crude prices in their tracks would be a sharp drop in demand.

What’s going to cause a drop in demand?

Well, to be fair, if Russia’s aggression expands, it could put a damper on economic activity in the Eurozone, not to mention travel to Europe.

However, this begins to dovetail into the immediate supply/demand factors influencing oil’s price.

***The Catch-22 for oil

Western governments are waging an economic war on Russia. And while those sanctions are certainly causing vast damage to Russia’s economy, they’re not targeting the biggest part of Russia’s economy – oil and gas.

In 2021, Russia was the world’s second-largest oil producer, with fossil fuels making up roughly 60% of its exports.

Clearly, if Russian economic devastation is the west’s goal, it would make sense to target oil and gas.

But doing so would be like pouring gasoline on the inflation fire that’s already burning through the U.S. and, to a lesser degree, Europe.

So, let’s explore the possible ways this Catch-22 works out:

One, the west does not sanction Russian oil. Russia continues to use oil-sale proceeds to stay afloat as it continues its aggression.

In this case, we’re facing a big unknown. Hopefully, the economic pain of the other sanctions will prove too much for Russian President Vladimir Putin and he’ll agree to a ceasefire. In this scenario, oil prices fall as the world breathes a sigh of relief.

However, that’s hardly guaranteed. Putin could be willing to let parts of the Russian economy crumble for “the greater good,” as he sees it, of Russian expansion. So, the aggression continues and oil prices remain around today’s elevated levels.

So, the outcome of this scenario is simply unknown.

Two, the west decides to change course and endure the economic pain of sanctioning Russian oil in an effort to completely kneecap Putin’s war effort. If that happens, it will cause a huge inflation spike in oil and gas. After all, Europe imports about 40% of its gas from Russia.

Here in the U.S., we’re far less reliant on Russian oil. Most of our imports come from Canada. However, given the global nature of the oil market, a spike in prices in Europe would certainly be felt in the U.S. This could significantly slow down U.S. economic growth.

In one sense, that could be good for U.S. stocks because it would likely slow down the pace at which the Fed raises rates. However, too much of an economic slowdown could push the U.S. toward a recession. By the way, the Atlanta Fed currently estimates that in Q1, GDP will see 0% growth, down from 0.6% on February 25.

Three, what if, counterintuitively, Putin stops supplying oil to the west?

Though this doesn’t seem likely on the surface, the reality is that if our sanctions have already hobbled the Russian economy, then there’s less for Putin to lose. He’s already shown a willingness to throw the Russian economy and its citizens under the bus.

So, if Putin feels boxed in, looking for an upper hand, what’s the west’s biggest Achilles Heel? Obviously, its reliance on Russian oil and gas.

If Putin weaponizes Russia’s gas exports, it could send the global economy into a recession.

From CNN Business:

How will Putin — who is also facing sanctions on his personal wealth from the West — fire back in what is rapidly morphing into economic warfare?

There is growing concern that Putin could retaliate by using not just natural gas but also crude oil as a weapon against the West.

“Russia’s energy supplies are very much at risk, either due to being withheld by Russia as a weapon or swiped off the market due to sanctions,” Louise Dickson, senior oil market analyst at Rystad Energy, wrote in a report Monday.

The worldwide supply of oil was already failing to keep up with demand. If Russia, the world’s No. 2 oil producer, intentionally held back supply, it would likely send oil prices skyrocketing, dealing a painful blow to consumers around the world.

JPMorgan has warned that oil would spike to $150 a barrel in the event that Russia’s exports are cut in half. That would translate to a roughly 41% increase from the recent high of nearly $106 a barrel.

***So, coming full circle…

Five-to-ten-year outlook for oil: Global demand will still be increasing, despite growth in green energy.

Two-to-five-year outlook for oil: Supply/demand imbalances are likely to keep prices elevated until new production hits the market.

The immediate outlook for oil is unclear, but the primary way that oil would drop is if Russia deescalates, and that doesn’t appear likely. Meanwhile, Putin deciding to weaponize oil is not out of the question.

Put it all together and it’s likely that oil is headed higher, even if there are bouts of volatility that bring its price temporarily lower.

Let’s return to Eric for the final word:

The death of oil is greatly exaggerated, and I expect its price to deliver some upside surprises over the next year or two.

A tightening oil market, coupled with a rising inflationary trend, provides ample reason to add an oil stock to your portfolio, at least as a hedge.

Have a good evening,

Jeff Remsburg