Looking for Oil

The perfect storm arrives: the Ukraine crisis, consumer price inflation, and scarce spare oil production capacity

The U.S. is currently producing about 11.7 million barrels of oil per day, about double the six million barrels produced domestically in 2012. (Photo: D. Thielen on Unsplash).

It’s only March but 2022 is likely becoming a landmark year — for all the wrong reasons. War in Ukraine, an ongoing (but generally diminishing) global health pandemic and now consumer price inflation. The Bureau of Labor Statistics’ Consumer Price Index (CPI) rose 7.9% between February 2021 and this February. This represents the fastest 12-month jump since 1982. And gasoline prices are a large portion of this dramatic increase— up 38% in the past twelve months. The average national price for one gallon of gas reached $4 on March 7, the highest average price since 2008.

U.S. domestic oil production peaked in late 2019 at about 12.9 million barrels per day. The shale oil industry contracted significantly as the coronavirus pandemic took hold in 2020. (Graph: US Energy Information Administration).

Oil. The source of recurring aggravation for consumers and political leaders alike. Since the American shale oil boom took hold in 2015, the U.S. has been less dependent on oil and petroleum imports from overseas. But oil is a global commodity with (generally) a global price.

Two things are important during this current oil price spike.

1. Spare oil capacity in the U.S. is minimal. Current U.S. production is about 11.7 million barrels per day, down slightly from pre-pandemic production levels of nearly 13 million barrels per day (late 2019, pre-pandemic). The collapse in oil demand in spring 2020 due to the coronavirus pandemic resulted in a decline in shale oil production in the U.S. as investors departed and exploration slowed dramatically. Today, with West Texas Intermediate trading at $107/barrel there is indeed incentive to drill and to invest in extraction but that takes time. U.S. production will likely hover around 12 million barrels per day throughout 2022. Russian oil exports into the U.S. are relatively small — a few hundred thousand barrels per day. But the prospect of up to seven million barrels per day of Russian oil not being available on the global market due to import bans, shippers refusing to carry Russian oil, or global lending institutions refusing to underwrite loans and investments all create upward pressure on oil prices — everywhere.

Releasing oil from the Strategic Petroleum Reserve along the Gulf Coast can help in the short term. But there are medium- and long-term challenges that will still put upward pressure on oil prices — from war in Ukraine to a resilient and recovering global economy. As the transition to non-fossil fuel energy sources continues, investment in oil, shale and natural gas will likely be modest even in the United States. This crisis provides the global community with the opportunity to research and invest in new renewable energy sources.

The primary oil and shale drilling fields in the lower 48 states. The Permian field is the largest, currently producing about five million barrels per day. That production will grow throughout 2022. (Image: U.S. Energy Information Administration).

2. OPEC+ can increase oil production — but by how much? OPEC+ (OPEC nations plus Russia, Mexico and several other producing nations) went through a disastrous price war in spring 2020 just as the coronavirus pandemic began. Key oil producers Russia, Saudi Arabia and the United Arab Emirates (UAE) reached a production agreement in May 2020 that served to stabilize prices. The ongoing agreed upon OPEC production quotas include Saudi Arabia producing about 10.3 million barrels per day (the same for Russia).

In total, OPEC members will likely produce about 28.5 million barrels per day in the coming weeks — and perhaps several hundred thousand more per day if the Saudis and UAE have the genuine spare production capacity. For the Saudis and the UAE, there is a seemingly difficult balance between upholding the current production agreement involving Russia and the importance of each nations’ relations with the United States, a long-standing security ally.

American producers, too, like Exxon Mobile and Chevron will increase production in the coming weeks and months. But this may only have a slighly moderating effect on oil and gasoline prices. The pandemic phase of COVID-19 is likely coming to an end and global economic activity will likely increase along with the arrival of the summer holiday/driving season in the U.S. and Europe.

Another wild card is Iranian oil. In the pre-sanctions period (2016), Iran was producing about 3.8 million barrels per day and exporting about 2.5 million barrels per day. An agreement with Iran in the coming weeks over its nuclear program would likely lead to Iranian oil exports which would put considerable downward pressure on oil prices — those talks are now paused effective March 11.

Petroleum with less than 0.5% sulfur is considered sweet. Petroleum with higher levels of sulfur is called sour crude. (Photo: M.Adams on Unsplash).

Additionally, most of Venezuela’s crude oil stock (Venezuela has the largest proven oil reserves in the world — 300 billion barrels) is considered extra-heavy and requires more processing for gasoline or other refined petroleum products. Light sweet crude is generally preferred for refining purposes.

The coming two decades may indeed see the beginning of the end of the oil era. But the transition will be slow and not entirely painless for consumers across the globe.