The two oil crises of the 1970s are notorious. In 1973, the oil price went from $3 a barrel to $12 a barrel in two weeks, and in 1979 the oil price rose from $12 a barrel to $33 a barrel. OPEC’s power was great in the 1970s. OPEC’s market share is now rising. This year, moreover, demand for oil will exceed supply for the first time.
Last year, oil prices already rose by 50 per cent. A new oil crisis is in the offing.
Investments are too low
There is insufficient investment in finding new oil fields. One of the reasons is that in recent years the oil price has been so low that oil companies have not considered it responsible to invest. Because of the long lead time between such an investment decision and the eventual production, there is a very long “hog cycle”. It is notable that the recent rise in the oil price does not encourage oil companies to invest more. This is because various stakeholders are pointing out that the fossil era is over. It is not only the campaigners in front of the door that are concerned: shareholders are also starting to stir.
The management of an oil company has to see with regret that their sustainable competitors are valued much more highly. Personnel prefer to go and work for another multinational. Even if the company would like to invest, this is made more and more difficult by governments, central banks and commercial banks. They don’t lend money to extract oil just like that.
Sometimes even the courts have been called upon to hold oil companies accountable for their climate targets. Because the energy transition is an expensive hobby that only the rich West can afford, the market share of non-OPEC countries is shrinking and OPEC, now plus Russia, can easily demand higher prices.
In the past, the price of oil rose each time OPEC gained a larger market share. Also, including OPEC+, investments in new oil fields are at a 15-year low. These investments are now insufficient to maintain production. Nevertheless, demand is close to 100 million barrels a day again, equal to the pre-Covid peak. Despite all the talk about the energy transition, it is not visible in these statistics.
Capacity limits in sight
Last year, OPEC+ spare capacity halved from 6.6 million barrels per day to 3.5 million barrels per day. OPEC is in the process of increasing capacity by 400,000 barrels per month, but in reality it is rather 250,000 barrels per month. It is possible that in the second half of this year OPEC+ will be operating at full capacity. In the 1970s, the trigger for the two oil crises was first the Yom Kippur War in which Israel was attacked by Syria and Egypt, and then the Iranian revolution, which caused a sharp drop in Iranian production.
In both crises, however, supply constantly outstripped demand worldwide. Only the sanctions of the Arabs against the Netherlands and the United States in 1973 and the fear of further escalation in the Axis of Evil in 1979 caused an explosion in the price of oil. Such events are unpredictable. Take for instance the recent unrest in OPEC member Kazakhstan. This country may only produce 1.5 million barrels a day, but if that was lost unexpectedly, capacity limits would quickly be reached.
Stocks are low
To counterbalance OPEC, the US government started a strategic oil reserve in 1975. No less than 714 million barrels of oil can be stored underground in Louisiana and Texas. That may seem a lot, but it is what the world consumes in a week. Along with all other countries, until recently almost 4 billion barrels of oil were kept in reserve. Last year, reserves fell by a total of 690 million barrels, which means that reserves are now at a five-year low.
Every day about 2 million barrels are withdrawn from reserves. These low reserves combined with the approaching capacity limits means that balance must come not from the supply side but from the demand side. In the 1970s, car-free Sundays were one way of slowing down demand. This means that people wanted to use oil, but were simply stopped by the government. In the 1970s, more than 10 per cent of income was spent on oil. Today, at the current price of oil, it is only a few per cent.
This means that the pain threshold at which the oil price actually starts to curb demand is much higher. Even with gas prices - which have risen fivefold in a year - demand is mainly determined by the weather, not the price. Of course, this is a sliding scale. With the price of oil rising, demand will gradually decline, but even with another doubling of the price of oil, we are now spending less on oil in percentage terms than we were in the 1970s. This is also because there is so much money available, thanks to the central banks. They can print money quite easily, but printing oil will be difficult.
The good news is that an oil crisis will accelerate the energy transition. Alternative energy can now compete with fossil fuels without subsidies. However, bear in mind that the low-hanging fruit has been picked as far as the energy transition is concerned. There are ambitious targets for CO2 reduction or even for achieving Net-zero. This cannot be achieved overnight. Since pretty much the entire economy runs on energy, the oil price will also contribute more structurally to a longer period of relatively high inflation thanks to the energy transition.
Han Dieperink is an independent investor, consultant and knowledge expert for Fondsnieuws. Earlier in his career, he was chief investment officer at Rabobank and Schretlen & Co. He is currently active as chief commercial officer at Auréus Asset Management. Dieperink provides his analysis and commentary on the economy and markets. His contributions appear in Dutch on Fondsnieuws on Tuesdays and Thursdays and in English on Investment Officer Luxembourg from time to time.