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Key Takeaways
- Oil prices dropped negative at the height of the pandemic thanks to lockdowns.
- Oil companies were unprepared when lockdowns were removed and the government provided stimulus money to citizens.
- A handful of events, including the pandemic, a looming recession, and the Russian-Ukraine war will influence oil prices going forward.
Oil prices have been on a wild ride over the past two years. They have gone from dropping to negative amounts at the start of the pandemic to $160 per barrel earlier this year, and have now declined by half their value since their highs. Investors and consumers are wondering what is going on with oil prices and where prices will go from here. Keep reading to understand what has been influencing oil prices and where experts think they are headed next.
Why did oil prices spike?
The common economic principle of supply and demand is the most significant factor in why oil prices have been so volatile lately. There have been both supply and demand disruptions that have had major impacts on prices. Here are a few critical events that have affected supply and demand over the past two years.
The pandemic
During the early days of the pandemic in 2020, oil prices saw an all-time low. The world suddenly had more oil than it knew what to do with because of worldwide lockdowns. Not only were people no longer driving as they worked from home, but domestic and international air travel also slowed. According to the BBC, with a glut of supply and very little demand, the price of a barrel of oil in April 2020 was negative $37.63.
Because of the oversupply of oil, oil companies began to slow and stop production. This became an issue when governments began issuing stimulus money to citizens, and countries began to ease lockdown restrictions. The demand quickly outpaced supply, causing prices to rise too fast for oil companies to keep up.
OPEC+ production cut
OPEC+, the intergovernmental organization of 13 oil-producing countries plus ten other major oil-producing countries, decided to cut production by 10 million barrels per day due to the oversupply of oil in 2020. This production cut would last until April 2022.
During this time, demand increased, but OPEC financially benefited from higher oil prices and had to walk a tightrope. They wanted demand high and production low to make as much money as possible. But they also had to keep other countries, like the United States, happy.
In an attempt to convince OPEC to start increasing production, President Joe Biden this past summer went to the Middle East, hoping to convince Saudi Arabia and other OPEC country leaders to increase oil production. This foreign policy attempt has so far gone nowhere.
Russia-Ukraine War
Russia is one of the world’s biggest oil producers and the primary source of oil for Europe. Because of their decision to invade Ukraine, many countries, including the United States, placed sanctions on Russia, specifically a ban on all Russian petroleum imports.
However, instead of hurting Russia financially, the sanctions benefited it as Russia found new buyers for its oil in China and India. The issue for the rest of the world is that the supply of Russian oil is not hitting the world market. The impact of a dearth of oil on Europe will unfold this winter as people look for ways to heat their homes, and the negative effects of a recent attack on the Nord Stream pipeline are hopefully resolved.
Routine maintenance
Further complicating the revamping of the oil supply is a slew of planned and unplanned refinery maintenance issues.
Refineries in California and Washington are slowing production due to routine maintenance and unforeseen maintenance requirements. Usually, refineries are shut down for maintenance every three to five years during the autumn season when demand is low due to less frequent travel.
For example, a southern California refinery experienced a fire that caused a halt in their production, forcing immediate repair. With the slowdown of production, supply has diminished, resulting in higher prices.
Biden administration shutting down Keystone Pipeline
The hike in prices during the summer of 2022 was also caused by people reducing their oil consumption in anticipation of an oil supply issue. The conversations around the Keystone Pipeline, which would have transported crude oil from Alberta, Canada, to Nebraska, divided many experts. Some believed the pipeline would not have affected oil prices by more than 1% this year.
Other experts, however, had put stock in the idea of America becoming fully energy self-sufficient with the Keystone Pipeline. While this pipeline was far from being completed when President Biden halted its construction, it would have provided a future oil supply and opportunities to export.
Why are oil prices falling?
In February, oil prices in West Texas had reached a high of $129.44, but on September 29th, the cost had dropped below $80 per barrel. There are a few factors for the oil price drop, including slow economic growth and OPEC.
In July, the OPEC leaders finally agreed to increase production supply by 3.1 million barrels a day, which is far from ideal, but it delivered enough oil to ease market demand.
In addition to this, President Biden has been ordering the release of oil from the strategic reserves. As of this writing, over 100 million barrels have been released. There has yet to be word on whether more releases will happen.
Finally, the US economy has been slowing and is on the brink of a recession. With the slowing of economic growth, people will consume less, and businesses will freeze hiring or possibly lay off workers.
Less economic growth means that there is less business activity, which ultimately means less demand for oil. The extra supply from the OPEC oil production increase, the release of strategic reserves, and the slowing of the economy has helped lower oil prices.
Who controls oil prices?
There is a lot at play when discussing the control of oil prices. Any one group or person does not necessarily control oil prices. The cost of oil instead operates under a market pricing system, meaning that the economic idea of supply and demand plays a huge role.
Thus, oil prices get set and influenced globally as well as nationally. Commodity traders on the world market speculate on oil prices depending on supply and demand.
If the commodity traders sense that oil production will be lower but demand will be high, they buy oil contracts, thus driving up the prices. Likewise, when oil production output is large and demand is low, traders sell oil contracts, lowering prices.
Oil prices are also controlled by shutting down production. Leading oil producers like OPEC can influence the cost of oil by increasing or limiting production. This is why so many experts have called for the United States to become energy independent, so we do not rely on other countries’ decisions to increase or decrease supply.
Where are prices headed this fall?
Most analysts expect oil prices to remain around $100 per barrel for the remainder of 2022 and 2023. They cite that the oil market has not fully priced in a recession, which tends to drop oil prices by around 40%.
But even with lower demand due to a recession, there is still a supply issue with Russian oil. On top of this, Saudi Arabia has hinted at decreasing output for OPEC to capitalize on the strained market. The reduction could happen as soon as October 5th when the group has its next meeting, shaving off a potential 100,000 barrels per day of their production.
One analyst believes oil prices will spike this winter due to Europe banning Russian oil imports. Their oil is a major source of supply for all of Europe, and if this winter is especially cold, we could see a considerable spike in the price of oil as demand rises significantly.
Bottom line
Even as the US and other countries transition to green and renewable energy, oil still plays a vital role in our daily lives. As a result, investors need to pay attention to oil prices now and where they are going, as prices have a significant impact on economies around the globe.
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