What price of crude is too high? The answer will surprise you
As crude oil prices climb to their highest levels in seven years, the question our clients are asking us is, how high is too high? We will say for now that current prices are nowhere near that point, and the way we arrive at an answer is by analyzing the “oil burden.”
Brent crude last week closed just shy of the $85 per barrel mark, and the 2021-to-date average stands at $68.65 per barrel. Despite the hype we are seeing about the rise in oil prices, they pose no appreciable threat to the global economic recovery.
The oil burden is the price at which global expenditures on oil rise above a level equating to 5 percent of the global gross domestic product. Our analysis has found that expenditures on petroleum above this percentage of
GDP tends to act as a dampener of economic activity.
In terms of the math, based on our forecast for global oil demand and using a median forecast for the 2022 global GDP, the price of Brent crude would need to average $130 per barrel (for the year) in order to push expenditures on oil to the 5 percent of the GDP mark. This annual average would likely entail a range of Brent crude over the course of the year extending up to $165 per barrel based on a separate analysis we published focusing on a range of oil prices we tend to see annually.
As you are reading this column, you have to appreciate the fact that just 10 months ago, “everybody knew” the price of crude oil would not be able to sustain levels above $60 per barrel. This is not us making a joke, nor are we being dramatic. Almost all market watchers were convinced that, firstly, OPEC production discipline would break down, and/or secondly, non-OPEC supply — particularly the US — would ramp up sharply once prices breached $60. Both of those suppositions have proven to be dead wrong. In point of fact, if we think about the key metrics for the global oil balance, 2021 has seen the following:
Global oil demand has come in higher than forecast, non-OPEC supply has come in lower than forecast, OPEC’s compliance with quotas has stayed above the 100 percent mark and global oil inventories have drawn by a record amount.
As we look forward, we expect to see a further tightening of the global oil balance, and with it, additional upward pressure on crude prices.
Of all the moving parts in the supply/demand balance, the one that has been the most contentious relates to the US oil production outlook. Moreover, in terms of just how contentious this topic has been, we can go back to OPEC’s historic quota deal in November 2016 (which was fashioned by Saudi Arabia) and the mass reaction afterwards that it was “sure to fail.” The No. 1 reason most were sure about a disastrous outcome related to US crude oil, namely that it would offset any OPEC production cut.
As a matter of record, the global oil inventory draw in 2017 was the largest in a calendar year back to 1971. As we have discussed in this column previously, we think we are seeing the twilight of shale, a view we first started publishing to our clients in 2019. But more on that in a future column.