The oil market has seen some severe challenges over the past five years. The pandemic up-ended global supply chains, and economic lockdowns devastated demand for the black gold, sending prices plunging briefly below zero.
As economies reopened and bounced back from the pandemic, oil demand surged, sending prices higher. Then Russia invaded Ukraine, setting off yet another market shock.
The energy market is still recovering from this disruption, nearly two years after the conflict began. Recent events in the Middle East have only compounded market concerns about supply.
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And in the background, there’s another issue - the world is trying to move away from hydrocarbon energy sources as it attempts to slow the impact of climate change. As this shift gathers pace, some analysts predict oil demand will peak in the next few years.
A challenging market
The oil market has always been challenging to try and predict.
The world consumes around 100 million barrels of oil daily, of which just over a third was produced by the OPEC cartel of oil-producing nations - led by Saudi Arabia - in 2022, according to the US Energy Information Administration (EIA).
OPEC+, which includes Russia, produces half as much again as the core group of OPEC countries. In total, the group of OPEC+ producers produce just under 60% of global oil consumption.
The world’s largest producer is the United States. The EIA estimates the US produced 14.7% of the world’s total output in 2022, compared to Saudi Arabia's 13.2% and Russia’s 12.7%. Middle Eastern producers account for 30% of global output.
This means the bulk of production of the vital commodity is in the hands of just a few producers. Moreover, approximately a fifth of global production moves through the Strait of Hormuz (according to the EIA), meaning any developments affecting this key supply route can have an outsized impact on global oil prices.
Those are the risks on the supply side. On the demand side, oil prices are heavily influenced by global economic activity. Even a slight downturn in economic activity can impact global oil consumption and, in this finely balanced market, impact on prices.
While the outlook for the oil market overall is unclear, there is a growing chance prices will remain elevated and possibly even move higher over the coming months.
Supply constraints are a growing problem for the market
A recent report from the World Bank laid out the challenges facing the market today.
Oil prices have moderated from the peaks seen in the immediate aftermath of Russia’s invasion of Ukraine, an event the World Bank described as “traumatic for commodity markets,” but this should not be interpreted as a sign the challenges have passed.
An escalation of the latest conflict in the Middle East could disrupt up to eight million barrels of oil production a day, both from producers in the region and tankers travelling through the Strait of Hormuz. That could send oil prices above $150 per barrel in the worst-case scenario, according to the World Bank.
Oil prices could also receive support from a lack of investment in the sector. Financial service companies have faced increasing pressure to scale back their investments in fossil fuels to enhance their green credentials. But this is already causing alarm in some circles that a lack of investment will hit oil supply before green energy assets come onstream, putting upward pressure on hydrocarbon prices.
At the beginning of October, OPEC Secretary General Haitham Al Ghais reiterated this warning, saying, "We are... running quite low on spare capacity, we have said this repeatedly, and this requires a concerted effort by all of the stakeholders to see the importance of investing in this industry."
As reported by Reuters, this view was echoed by the CEO of US oil producer Occidental Petroleum, Vicki Hollub, who has warned that low investments will drive energy prices higher.
The opportunity in energy
The outlook for oil prices in the near term is uncertain and depends on how the situation in the Middle East and Eastern Europe develops over the next few weeks and months.
It also depends, to a certain extent, on what happens in the global economy. If the US and Europe slide into a protected recession, oil demand will fall, which could weigh on prices.
However, the outlook for oil prices in the next five years seems far more positive. Oil demand is projected to remain robust throughout the rest of the 2020s, but supply will likely come under pressure due to a lack of investment.
There’s also a high probability the market will see further supply shocks, which will only add upside pressure to prices.
With the risks skewed to the upside, the market may be missing the opportunity in energy.
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