Quick Bites | What’s happening with Oil prices?

Since the beginning of the year, the price of oil has climbed around 18%. Brent crude, the global benchmark, is hovering near $85 a barrel. Futures markets show that traders expect the price of oil to decline over the next year, but an escalation of geopolitical tensions could alter that projection.

Source: Trading Economics

The hot/cold conflict between Iran and Israel is a case in point. Iran is a major power in the Persian Gulf, and tension with Israel creates major uncertainty. In particular, the Strait of Hormuz, between Iran and Oman,  ranks as the world’s most important oil choke point. About 20% of global petroleum liquids consumption flows through it, and if traders were to begin to panic about the vulnerability of oil there, prices would shoot higher.

At $100 a barrel, or even worse, at $120, steeper oil prices would start to bleed into core inflation, potentially slowing its descent toward central bank targets, and putting equity markets’ recovery at risk.

The Persian Gulf is not the only geopolitical hot spot. In June 2022, early in the Russia-Ukraine war, Brent oil exceeded $120 a barrel. That war could disrupt oil supplies again, too.

But most important for oil prices are the supply and demand dynamics. Here we will briefly mention the supply side. 

The Organisation of Petroleum Exporting Countries (OPEC) and its allies, a group that produces around 40% of the world’s crude, wants to keep oil prices high and stable. Lately, they have been stable, even if not that high. Despite the recent death of Iran’s president and the war in Gaza, prices of Brent crude have stayed within a few dollars of $82 a barrel since the start of May.

Part of the reason why OPEC is failing to keep prices high is because its members do not keep to their output targets. In March, the group’s leaders and Russia extended production cuts, vowing a reduction of 2.2 million barrels a day, or 2% of global supply, until the end of June, on top of 3.7 million barrels per day of previously agreed cuts for 2024. Yet OPEC is now overproducing so much that its daily output in 2024 is little changed from the last quarter of 2023. This will create tensions when members get together to decide their strategy at their next ministerial meeting.  

OPEC and its allies have two types of cuts in place: compulsory reductions, which apply to all members via quotas, and voluntary cuts, announced by the big producers, including Saudi Arabia, Russia, and the United Arab Emirates. The problem is that individual producers have an incentive to cheat, selling above their quotas and free riding on the efforts of others to keep prices high, to increase their own revenues.   

The worst offenders, Iraq, and Kazakhstan have consistently flouted commitments. Russia, which is ever less compliant, appears to like the effect of announcing cuts but dislikes selling less, probably because it needs to finance its war effort. Some estimates suggest that even Saudi Arabia, the cartel’s de facto leader and traditional enforcer, has been overproducing slightly. These countries must hope that producers such as Azerbaijan, Nigeria and Sudan continue to pump below their targets, as they are doing now, because of graft, underinvestment, and war.