Brent crude prices were around $70 a barrel before the pandemic hit in 2020. The prior high was around $86 a barrel in October 2018 when the market got way ahead of itself despite all the rising trade tensions.
Oil has always been about timing. It has not been in short supply going all the way back to 2014. Since the time of the U.S. shale oil boom, oil prices have bounced up and down in mini cycles as demand has not been the problem; it has always been about supply. Since President Trump last year reached a deal with OPEC (namely Saudi Arabia) and Russia to trim back 10 million barrels per day, oil prices have done a remarkable job in bouncing from less than $30 a barrel all the way to $74 a barrel for Brent today. So, what changed?
Since the U.S. shale boom the three dominant producers of oil have been the U.S., Saudi Arabia and Russia. The U.S. effectively produced around 13 million barrels per day at the peak, followed by the latter two producing closer to 10 million to 11 million barrels per day. They have been the swing producers, so to speak.
When the pandemic hit, U.S. shale lost about 2 million barrels per days, which is not expected to come back until much later. Banks and investors are tired of lending shale producers more money to produce more oil, generating lower and lower margins. This time around it seems that prices will need to move a lot higher before they even think about leveraging themselves again.
In addition, the larger exploration and production companies and the majors are now focused on returning cash back to shareholders via dividends and buybacks, especially as they have disappointed them time and again over the past decade. The U.S. rig count has picked up but not back to pre-COVID levels despite higher oil prices and U.S. shale production is taking its time to come back, too. But it is all about pricing, and with prices above $70 a barrel for West Texas Intermediate (WTI) crude it is surely enticing for any U.S. producer.
As climate change becomes forefront of most companies' agendas they are more reticent to produce fossil fuels lest they upset their investor base. It is for this reason the U.S. has stopped being a swing producer for now. Russia has always played the economic game -- it produces less as prices fall and more as they move up, but is pretty much consistent. That leaves OPEC, which is mostly Saudi Arabia. They have been one of the biggest price influencers over the past year in terms of the big swings due to changing strategy each time.
To look at it simply, OPEC has one crown jewel, and that is oil. They have a vision to diversify away from this into other ventures such as renewables given their domestic policy goals and vision for 2030. They need to monetize on their oil reserves and maximize production and revenue to be able to diversify their income stream. How else to achieve this other than high prices?
Of course, they cannot let prices run too far, either. Before President Biden, Trump liked to coerce them into increasing production and lowering production, keeping the U.S. consumer in mind at all times. But Biden does not seem to interfere much with OPEC oil policy. And for now, they are using the "recovery is still fragile" as justification to keep the oil market tight and prices supported.
OPEC+ is also lucky from a seasonal point of view as summer typically sees a pick-up in demand from driving, hence higher gasoline demand, which means refiners need to buy more oil to make more gasoline. The same thing happened back in first quarter during the Texas freeze, when Saudi Arabia decided to take another 1 million barrels per day out of the market for two months during the time when market was going through a cold snap.
The other big factor driving oil's price has been commodity index inflows, the inflation backdrop. There is no doubt that we are witnessing very high inflation. Federal Reserve Chairman Jerome Powell has acknowledged that this is going to last a lot longer than they thought. As money comes into these index funds, a lot of these funds are still heavily weighted in oil, hence support the price that way as well.
It is important to distinguish between actual tight markets and tightness over a short window of time. As we said, the oil market has never been short of supply, it has just been held back in a very timely manner by those who are the swing producers. But it is important to keep both the macro and micro perspective in mind as both dictate commodity prices. We just saw what macro headwinds can do to copper, gold and silver, as they have fallen 8% over the past few weeks, and that is still with very "tight" markets.