Editorial: OPEC back at the wheel

Markets counted on demand for oil and gas returning once restrictions related to the COVID-19 pandemic began to loosen. The only questions were how fast and with what timing.

What nobody predicted, however, was that a return of demand for road fuels and other products derived from crude oil would coincide with a spike in natural gas prices so sharp—reaching roughly $40/MMbtu in Europe and $35/MMbtu in Asia—it would prompt additional demand for crude and refined products to help meet power-generation demand as a gas substitute. And all this before winter has even arrived.

A combination of upcoming seasonal demand and below-average US gas inventories prompted the Energy Information Administration to predict benchmark Henry Hub natural gas prices will average $5.67/MMbtu between October 2021 and March 2022, the highest price for the season in 14 years. US retail gasoline prices, meanwhile, are more than $1.20/gal above year-ago pricing, lifted by crude prices at 7-year highs of more than $80/bbl.

Morgan Stanley on Oct. 19 increased its first-quarter 2022 Brent price forecast to $95/bbl and its long-term forecast (2023-30) to $70/bbl from $60/bbl, while acknowledging that at some point demand destruction will occur. It sees this happening late this decade after a peak of roughly 105 million b/d. By contrast, the financial firm expects peak supply by mid-decade, as capital expenditures continue to stagnate or weaken.

Despite such prices and projections, however, US crude exports continue to accelerate. ESAI Energy expects crude leaving the US to reach 3.1-3.2 million b/d in October, up from about 2.6 million b/d in September, driven by increased demand from Asia spurred for relatively cheap West Texas Intermediate (WTI) pricing. WTI’s discount to Brent crude prices reached roughly $4/bbl in early October before narrowing to around $1.50.

Both the Organization of Petroleum Exporting Countries and its allies (OPEC+) and US producers have so far shown output restraint. With good reason. The crude oil market is still structurally long and the ability to forecast either short- or long-term demand more tenuous than it’s been in some time.

The Biden administration last month both flirted with the idea of releasing oil from the Strategic Petroleum Reserve and asked OPEC+ to increase exports. The former would have been little more than a symbolic gesture given the scale of the global market. While the latter, an effort joined by Japan, is something the Saudis and Russia so far have shown little inclination to do.

Mythical independence

The current situation clearly illuminates the falseness of politically motivated claims that the US had once achieved energy independence and has now somehow lost it. If the US had that sort of supply might, it would be able to produce its way to lower prices. It doesn’t and can’t. The only entity that does, still, is OPEC+.

Talk of such self-sufficiency also belies a misunderstanding of the way the US market works. Unlike in Saudi Arabia, or Russia, or Iran, or Venezuela, the oil produced in the United States belongs to the companies that produce it. These companies—some of them US-based, some not—are free to sell it wherever they can get the best price. That’s why crude exports continue to rise.

Prices aren’t high because of cancelled pipelines or a pause in oil and gas drilling leases. They’re high because, in the present, demand for crude has outstripped supply.

On the supply side, it’s only a matter of time before prices get high enough that both private operators and national oil companies (often the largest source of revenue for their country) decide to cash in by increasing output. High prices will also eventually create not only short-term demand destruction but an environment in which longer-term alternative solutions become more appealing.

The market hasn’t lost its ability to self-correct. And it will.