What factors influence the future of oil?
As world oil’s upstream and downstream industries stand at a crossroads, investors globally face the challenge of deciphering innumerable geopolitical and economic signals. These signals will also directly impact inflation rates with implications for central bank interest rate policy. For investors, the outlook for oil holds more than the usual amount of sway. From potential upheavals in the Middle East to colossal mergers in the U.S., here’s a shallow dive into the factors influencing the future of oil.
A recent report from the World Bank paints a grim picture for global oil supplies. Amid escalating Middle Eastern tensions, the World Bank suggests even minor disruptions could remove anywhere from 500,000 to two million barrels daily from global markets. Should this happen, the market could witness price surges ranging from U.S.$93-102 per barrel and, if conflicts further expand, a medium-scale disruption, stripping three to five million barrels daily, might elevate prices to U.S.$121 per barrel.
The most ominous projection from the World Bank envisions a gargantuan disruption, reminiscent of the 1973 Arab oil embargo, potentially wiping out six to eight million barrels daily. In such a scenario, prices could touch U.S.$157 per barrel.
However, it’s worth noting that the ongoing Israel-Hamas war has yet to make a dent in the oil market. This apparent market stability may underscore the global economy’s enhanced ability to endure oil price shocks. A capability shaped significantly after the 1970s energy crisis, thanks to countries diversifying their energy portfolios, reducing oil dependence, and creating strategic petroleum reserves.
Speaking of strategic oil thinkers, the American oil landscape is undergoing a tectonic shift. Recent mega-mergers are reminiscent of Chevron’s colossal $36 billion acquisition of Texaco in 2000. ExxonMobil’s U.S.$64.5 billion takeover of Pioneer and Chevron’s acquisition of Hess, in a deal worth U.S.$60 billion dominate the headlines, with the former deal giving Chevron materially more resources to allocate to exploration in Guyana, North Dakota, the Gulf of Mexico and the Gulf of Thailand, simultaneously alleviating Chevron’s portfolio concentration risk. And that says nothing about the implied divergence between Europe and the US’s energy transition strategy.
Historically, mergers and acquisitions (M&A) in the oil sector signalled consolidation due to unfavourable economics. However, the narrative has evolved. Today’s mergers seem a lot more optimistic, heralding a new era of growth. For instance, ExxonMobil and Pioneer have ambitious plans to enhance production by a whopping 700,000 barrels of oil and gas daily over the next four years.
ExxonMobil’s Chief Executive Officer (CEO), Darren Woods, captures this sentiment aptly: “It’s not about cutting back; it’s about building up.” These words reflect a broader industry sentiment: oil demand will remain robust despite potential peaks currently expected in the 2030s.
While European oil giants transition towards climate initiatives and diversification, their U.S. counterparts are placing bold bets on oil. The big question on many an investor’s mind: is this optimism justified?
For perspective, while advanced economies project a decline in oil demand over the next two decades, many parts of the world forecast a stark rise. The organisation of the petroleum exporting countries (OPEC), for instance, predicts a rise in oil demand until at least 2045. Such forecasts suggest that the oil market will continue to thrive for the foreseeable future.
We have written about, for example, the number of internal combustion engine (ICE) cars that will remain on the road even as electric vehicles (EV) are adopted. In a 2021 blog post entitled Why we Invest in both Petrol Stations and the EV Revolution, I noted:
“There are 20 million registered vehicles on Australia’s roads (including motorbikes presumably). Each year about one million new vehicles are sold with about 300,000 of those added to the total fleet and the remaining 700,000 replacing existing vehicles.
“According to the Australian Electric Vehicle Council, 6718 EVs were sold in 2019. In 2020 that number rose to 6900 and while sales surged in the first half of 2021, only 7248 electric vehicles were sold in addition to 1440 plug-in hybrids (PHEV).
“Even if every new car sold was an EV or PHEV, and the total Australian fleet continued to grow at the current rate of 1.5 per cent (with the current 3.5 per cent of the fleet replaced each year), it would take 23 years before the entire Australian fleet is fully electric.
“Today, only 1.4 per cent of annual sales are EVs (albeit sales are accelerating). At this rate, it will take more than three decades, and perhaps four, for Australia’s internal combustion engine fleet to be entirely replaced by EVs.”
We can now shorten the period for the fleet to be fully transitioned because, at the end of June 2023, three times more EV’s were sold than the previous year, and EVs now represent 8.4 per cent of all new cars sold in Australia. Nevertheless, we are still talking decades.
Further complicating this global jigsaw is China. As the world’s largest oil importer, China’s economic pulse is intertwined with Middle Eastern stability. With nearly half of its oil imports sourced from the Persian Gulf, any upheaval in the region poses significant risks.
And separately, China has just banned exports of graphite, a fundamental ingredient in EV battery production, of which China supplies some 85 per cent.
China’s reliance on the Middle East isn’t limited to oil. Its ambitious Belt and Road Initiative seeks to integrate the Middle East further into its global strategy. Hence, Beijing’s recent diplomatic endeavours, promoting peace in the region, are as much about global strategy as they are about energy security.
However, can China’s delicate diplomacy bring lasting peace to the historically volatile Middle East? As Steve Tsang, director of the school of oriental and African studies (SOAS) China Institute in London, aptly puts it, “China wants to be respected everywhere, but will it do what’s needed to resolve hard regional security issues?”
Once again, as the oil industry stands at a critical juncture, investors need to maintain a keen eye on developments. The intertwining of geopolitics, economics, and energy ensures that any slight shift can ripple across markets, inflation, interest rates and central bank responses.