• As crude oil prices near triple digits, it isn’t just consumers feeling uneasy

Jinjoo Lee, WSJ

NEW YORK
EnergiesNet.com 06 23 2023

Rising oil prices are, generally speaking, wonderful for companies that pump it out of the ground. But only up to a point. 

Crude near $100 a barrel might be an unattractive price for everyone involved. After spending most of this year below the $90/barrel mark, the global benchmark Brent price edged above that threshold in early September after Saudi Arabia and Russia said they would extend voluntary oil production cuts through the end of the year. Now even some bearish analysts are forecasting that it could hit triple digits, at least briefly.

While shares of oil and gas producers mostly moved in lockstep with the price of oil over the past year, that relationship has tellingly broken down. Since Sept. 8, when Brent crude closed above $90 a barrel, oil prices have risen by another 2.6%, while an index of oil producers has declined 5.3%. The index’s pullback could be a natural breather after heady growth since 2021, but there is good reason for energy investors to think less is more.

One reason for caution is high prices’ impact on demand. Generally speaking, oil prices above $100 a barrel tend to be motorists’ pain point, spurring some to drive less. In June and July 2022, when Brent crude prices averaged roughly $110 a barrel, gasoline demand in the U.S.—the biggest consumer of oil—fell 4.1% compared with the same period a year earlier when prices had a $70 handle. The year-over-year gap in gasoline demand narrowed in the following months as oil prices fell.

And Americans might soon have new reasons to feel frugal. In August, American households making $50,000 to $100,000 a year had about 50% more in their savings and checking accounts than prepandemic levels, down from an excess of nearly 100%, according to the Bank of America Institute. Their wallets are at risk of even more erosion when student-loan repayments are set to resume next month—to the tune of $100 billion a month by some estimates.

The risk of a pullback in fuel consumption is especially high in developing countries. While oil prices and the value of the U.S. dollar often move in opposite directions, they have been rising in tandem recently, notes Ilia Bouchouev, managing partner at Pentathlon Investments. That places extra pressure on countries such as China and India that must buy dollar-denominated oil. 

“It causes a double whammy, where oil price appreciation is amplified by U.S. dollar strength and local currency weakness,” he said.

In dollar terms, Brent crude prices have moved up about 7.4% year to date. In Chinese yuan terms, they are up 13%. While the price cap on Russian oil helps cushion that impact, China and India source oil from other countries, too.

Moreover, crossing a psychologically significant price is likely to elicit government responses that are unfavorable to energy companies. Record oil company earnings last year prompted the European Union to impose a windfall profits tax on fossil fuel companies. President Biden has threatened to do the same in the U.S. And the longer high prices persist, the bigger the government response is likely to be. The U.S. passed its fuel economy standards in 1975 after the oil-price shocks of the early 1970s, for example.

What is the sweet spot then? Dan Pickering, chief investment officer at Pickering Energy Partners, estimates that oil at $75 to $90 a barrel is the price at which producers make acceptable returns and where demand is “right on the edge of being crimped.” The futures curve certainly reflects that expectation: Oil contracts for October 2024 delivery, for example, are changing hands below $84 a barrel today.

There are other reasons to think oil won’t stay above $100 a barrel for long. Saudi Arabia, which holds some 3.3 million barrels a day of spare capacity, according to the International Energy Agency, has a strong incentive to bring more oil to market if it sees signs of the commodity’s price crimping the global economy. That doesn’t mean oil will stop flirting with $100 a barrel, though. Given signs of a slowdown in U.S. shale production and the diminished spare capacity across oil-producing countries, oil is likely to “regularly go up to $100 a barrel and also regularly pull back,” says Arjun Murti, partner at energy investment firm Veriten.

It is possible for oil to stay above $100 a barrel for a long period if some kind of physical disruption or unforeseen geopolitical twist presents itself. But that is a scenario that no one should be wishing for—not even Big Oil. 

Write to Jinjoo Lee at jinjoo.lee@wsj.com

wsj.com 09 23 2023