Oil market: issues and outlook

ARTICLE: From the start of the millennium - to be more precise since 1999 - till around the middle of 2008 when the Global Financial Crisis (GFC) went into full gear, oil market saw a virtually unfettered rise in prices in terms of both crude and WTI (West Texas Intermediate). To be more precise, on end-January 2000 crude-oil futures prices stood at $25.97 a barrel for Brent, and $27.64 a barrel for WTI. By the middle of 2008, prices for both had soared to $139.83 a barrel for Brent; with only short-lived dip in January 2002. The main underlying reasons included both significantly rising energy needs for booming economies like China and India, and to a lesser extent in some other emerging economies, and cuts in production by OPEC (Organization of the Petroleum Exporting Countries).

Later on, prices continued to rise till around end of April 2011, when Brent soared to as high as $125.89 a barrel with WTI following a similar trend. The prices continued to remain stable around this level till end-June 2014, when they fell drastically, where Brent nosedived - and WTI a little more - and it settled at $52.99 a barrel by around end of January, 2015, to have ultimately fallen at the back of essentially strengthened US dollar, and an oil glut due to significant production investment in the wake of economic re-built effort following the GFC. These causes led to a further slide of both Brent and WTI for another year or so, when their prices had ultimately settled at $36.57 a barrel for Brent, and a little lower at $33.62 a barrel for WTI.

Another recovery period for both Brent and WTI started, which peaked at around end of October at approximately $83 a barrel. There were slightly downward fluctuations, when finally at the time of the Covid-19 shock of they stood at around $66 a barrel for both Brent and WTI by end-December 2019. By April 21, 2020, the pandemic shock causing a significant drop in both aggregate demand and supply of oil (in fact a lot more drop in demand than supply) had led to an unprecedented fall in the prices of crude, which had fallen to $19.33 a barrel for Brent, and $11.57 a barrel for WTI.

Since then, there is somewhat recovery in oil prices to around $40 a barrel for both Brent and WTI on the back of mainly unprecedented cut in supply, and an uptick in economic activity after receding lockdowns. More recently, the initial success in 'Moderna' experimental vaccine, where a recent Wall Street Journal article Oil prices rise on vaccine hopes, falling inventories "Wednesday's gains for oil came with stocks and other investments climbing after new details about the first human study of Moderna Inc.'s experimental vaccine showed that it induced the desired immune response for all 45 people evaluated. Researchers said the results bolstered their decision to start a large clinical trial slated to start later this month. The Moderna shot is just one of the clinical trials planned in the coming weeks, and traders will be closely monitoring the results to gauge how quickly a vaccine could ease the damage caused by the pandemic and support consumer confidence."

Having seen a rise in oil prices, analysts believe that the recovery in prices to around $40 a barrel will not be enough to allow the energy sector to salvage itself in terms of its debt obligations, and work on any significant future production plans, especially for moving into a zero-emissions category of oil production.

An article Behind oil's rise is a historic drop in US crude output points out that "US crude supply is falling at its quickest pace ever, easing a global oil glut and spurring a swift recovery in fuel prices. Yet oil's push back above $40 a barrel as drivers return to roads isn't enough for beleaguered shale producers, which until recently were the driving force behind a transformation of the global energy industry. For many of them, prices haven't risen far enough to help ease the strain of debt taken on during boom times. And the need to cut output in the face of pandemic-hit demand means they can't pump their way out of trouble...

The tumble in domestic supply and record output cuts from the Organization of the Petroleum Exporting Countries and partners including Russia are supporting oil prices after they collapsed earlier in the year."

Given an uncertain future, due to the unclear situation with regard to resolving the pandemic crisis, it increasingly appears that the outlook for the oil sector stands at a crossroads. This would mean a different set of signals for policy planners in oil exporting and importing countries (like Pakistan). On one hand, there are concerns that the demand for oil may never really pick to a pre-pandemic level at the back of greater push for cleaner energy solutions, so as to weaken the link between carbon emissions, climate change, and future pandemics. A recent article Oil went below $0. Some think it will rebound to $150 one day in Wall Street Journal highlights this concern as: "In the long run, most analysts agree prices should gravitate to a level at which energy producers profit from making just enough crude to match demand. Covid-19 has made that calculation more complex. Investors are unsure whether the pandemic will permanently alter transport and consumption patterns, or expedite the move toward cleaner energy sources."

Hence, a significant move towards cleaner energy. It would translate a lower demand for oil due to changing preference for transportation modes - using more bicycles for instance - and greater inclusion of technology to cut back on travel. This would mean that crude prices will remain around $60 a barrel for the next decade. This is in contrast to the other side of the oil sector dilemma with regard to oil prices' outlook, which expects the prices to bounce back to as high as $150 a barrel over the next five years because oil production will continue to remain low due to a fall in profits and consequent lower investments.

The same article indicates with regard to this debate the following: "Some think the bust will set in motion a boom, predicting that investment in oil-and-gas production will dry up and propel crude prices back above $100 a barrel.

'That funding pressure is going to be massive. It's going to be really difficult for some of the producers to produce'; said Trevor Woods, chief investment officer of Ohio-based hedge fund Northern Trace Capital. 'We could hit $150 pretty easily by 2025.' Others say the pandemic will sap fuel demand after the threat of contracting coronavirus has faded, cementing an era of cheap oil... Such predictions are at odds with the futures market, which pegs Brent crude at less than $60 a barrel for the rest of the decade."

Given this global context, for an importing country like Pakistan, where a weak economic institutional setup did not even allow it to take advantage of the unprecedentedly low oil prices, to a lower oil prices for public with positive consequence for inflation, or b) reach a far more reduced oil import bill, or c) bring down electricity tariffs, where a significant portion of production is furnace-oil based would have to actively plan for either of the two scenarios with regard to outlook of crude prices in terms of low and high levels of them. On a related note, Pakistan should look to move towards cleaner energy sources since it is one of the leading countries to get affected by the fast approaching climate change crisis. Moreover, such a shift will help towards reducing oil import bill - an important component for the country's balance of payments - and also for helping alleviate the unemployment crisis in the wake of the pandemic since green and renewable energy sector produces a lot more jobs than fossil fuel-based energy.

(The writer holds PhD in Economics from the University of Barcelona; he previously worked at International Monetary Fund). He tweets@omerjaved7

Copyright Business Recorder, 2020