by Raihan Woodhouse
Image: Michael Elleray / Creative Commons
Oil is the most important energy commodity in the world and a primary determinant for the costs of production and manufacturing across industries. Appropriately, investors use oil prices as a valuable indicator of the economic climate. The oil industry was left traumatized in early 2020 as energy demands plummeted due to lockdowns and travel bans prompted by the COVID-19 pandemic. The surplus of oil coupled with dwindling demand caused a rapid drop in oil prices globally as Brent Crude, the international benchmark for oil prices, fell from $68.91/barrel in January of 2020 to $20.46/barrel in April of 2020. Even more astonishingly, the price of oil in the United States, as indicated by the West Texas Intermediate [WTI], turned negative to $–37.63 in April 2020.
Despite the much turbulence, the price of oil has experienced a gradual and natural recovery into 2021. Brent Crude recently hit $60.27/barrel, its highest since January of 2020, putting its year-to-date rise at around 15 percent.A detailed analysis of the current global economic, political, and social atmospheres, further reveals more significant reasons to be bullish about oil markets. This provides the answer to one of the most pressing questions regarding the outlook for oil in 2021: what can the market expect from oil and what impact will these forecasts have?
Oil prices are on a steady recovery since mid 2020 and are further stimulated by President Joe Biden’s comprehensive vaccine roll-out program that aims to end coronavirus lockdowns in the United States. According to data published by Bloomberg, in the US alone, the population that has received at least one dose now exceeds the population tested Covid positive since the pandemic began. To achieve this, the Biden administration has worked towards vaccinating 100 million people in 100 days, meaning approximately 1.5 million Americans per day. This course of action prompted the US public health official, Dr. Anthony Fauci, to boldly declare that by “the end of 2021, we can approach very much some degree of normality that is close to where we were before.” While the extent to which his words are true may be questioned, there is no doubt that High-Income Countries [HICs] and their economies can begin to re-open and recover towards the fourth quarter of 2021. This would induce an influx of consumers back into the economy with inherent demands for energy. These demands will drive up the prices of oil manufacturing and production processes across sectors could be restored.
Additionally, the administration introduced a gargantuan $1.9 trillion fiscal stimulus package that intends to sustain economic growth in the US by encouraging individuals and businesses to purchase. The combination of vaccine rollout and the stimulus package back strong confidence to invest in the oil market now.
On the other hand, it is for the aforementioned reasons that there is a divide in the investment world pertaining to oil. It is important to note that while “the oil market is crawling back to normality, there is an excessive degree of bullish exuberance floating around,” as said by Stephen Brennock, an oil analyst at the oil brokerage PVM. Generally, what makes the upward trend of oil prices all the more puzzling is that, similar to the US stock market, it arrives at the time of lockdown extensions, suggesting an inevitable delay or reduction in the demand for oil. Furthermore, it is of utmost importance to note that the aforementioned optimistic assumptions could lay the groundwork for a swift correction of oil markets if demand does in fact weaken further. This is because many Low to Middle-Income Countries and their economies remain under restrictions imposed due to the pandemic. These countries lack the necessary resources to conduct efficient and large vaccination programs; this would delay the re-opening of developing economies where most manufacturing and production processes are located. Thus, an air of uncertainty due to the sensitivity of the market sparks bearish speculations, especially given the recent tensions within the Organization of Petroleum Exporting Countries [OPEC] and its constituents.
Saudi Arabia and Russia’s current dispute over oil management and production cuts intensifies the uneasiness of investors. In January of last year, Saudi Arabia decided to cut production of an extra 1 million barrels a day from its supply, a figure beyond its OPEC+ obligations. Saudi Arabia proposed an extra cut to further tighten the supply in the market that has been one of the factors that supported the oil price rally in recent weeks. Now that the price of oil is above $60/barrel, analysts believe that Russia will aggressively push for an easing on the cuts starting this April—an awfully inconsiderate and individualistic approach towards an intergovernmental organization with such a significant influence on global commodity prices—given the betterment of the pandemic in the country. Russia must keep in mind that a rapid expansion of supply with lackluster demand creates a surplus that would weaken the market. Nonetheless, great faith should be placed upon Saudi Arabia as one of the founding members of OPEC, who, optimistic investors believe will remain resilient on its proposed cuts as negotiations progress.
These policies reveal projections for great under-investment in the oil industry. For example, BP surprised investors with plans to shrink its oil and gas production by 40% over the next decade while Shell detailed plans to cut up to 9,000 jobs by the end of 2022 to ramp up the development of renewable energy. Analysts predict that this will cause a supply-gap over the next few years as the supply of oil catches up with possible demand, consequently driving the price of oil upwards. Exchange and regulatory data suggest that hedge funds have increased their bets on rising prices through futures and options contracts while Wall Street banks, including Goldman Sachs and JPMorgan Chase, have informed clients that they believe prices could push higher.
Altogether, while the demand for oil remains at relatively depressive levels from the economic fallout caused by the pandemic—with jet fuel particularly hard hit—the future is encouraging for commodities. Whilst it is important to acknowledge the precariousness of the markets right now, the significance of the vaccine rollout, the stimulus package, recent movements by hedge funds and investment banks, OPEC negotiations, and a future potential supply-gap could all boost demand as economies come back online. These ongoing and predicted trends provide sufficient justification for a bullish outlook on oil prices in 2021. Observation, however, must be kept close, as price outlooks remain attentive to the movement of equity markets.