[Lee Jong-woo's Economic Reading] International Oil Prices Soar Amid War Fears... Expected to Stabilize in the $80 Range in the Second Half

Sales Ban on Russian Products
Short-Term Rise in First Half
OPEC+ Production Cuts End in Q3
Stability in Second Half with Iran Nuclear Deal
Structural Changes Needed in Supply and Demand

[Asia Economy] When Russia invaded Ukraine, international oil prices briefly exceeded $100 per barrel. It was the first time in 10 years. Since oil prices were around $60 per barrel at the beginning of last year, this represents an increase of nearly 70% within a year. Although prices quickly fell back to the $90 range, they have not escaped an unstable state.

The fundamental reason for the sharp rise in international oil prices is the imbalance between oil demand and supply. Oil demand has increased significantly due to the global economic recovery. Last year, the average global economic growth rate was in the 6% range, with growth rates in the US and Europe exceeding 4%. Thanks to the improved real economy, demand for raw materials surged. On the other hand, supply growth was not noticeable. Despite high oil prices, major oil-producing countries such as Saudi Arabia showed little enthusiasm for increasing production. They did not want a situation like in 2007 or 2018, when production increases led to a sharp price drop and disruption of the oil market.

US shale oil also failed to play a calming role in oil prices. In November last year, the US Energy Information Administration (EIA) announced that there were about 4,800 drilled but uncompleted wells (DUCs) in the US. It is estimated that the actual available DUCs, excluding low-productivity wells, number around 2,800 to 3,500. Unlike oil fields in the Middle East, shale oil fields are small in scale, so production volume depends on how many DUCs are secured. Without DUCs, even if there is a desire to extract oil, it is impossible to do so.

Increasing oil supply requires a lot of time. From exploration to drilling and production takes more than five years, so current production facilities were likely decided based on oil prices from five years ago. In 2017, five years ago, oil prices were about $45 per barrel. This price level does not provide strong incentives for active oil development, and its effects are now being seen.

Geopolitical risks between Russia and Ukraine have added to this situation. Russia is the world's largest natural gas exporter and the third-largest crude oil exporter. Because of this status, any problems between Russia and Ukraine inevitably affect international oil prices. Some argue that there will be no problem this time, citing the case in 2014 when Russia invaded Crimea and international oil prices did not rise. However, the situation then and now is different. At that time, supply was in surplus due to increased oil production by non-OPEC countries, but now demand is higher, so if Russia's oil exports are disrupted, international oil prices will inevitably rise.

When Russia invaded Crimea in 2014, Western countries imposed several rounds of sanctions. In March, at the time of the invasion, sanctions were implemented in the financial, defense, and energy sectors, including blocking Russia's funding channels. In July, sanctions expanded to the real economy, including freezing assets of individuals and companies, banning bond issuance, and restricting imports and exports of certain items. Each time these measures were taken, tensions between the two sides escalated. This time, sanctions are likely to start with energy. The intensity of sanctions will be stronger, not weaker, than when Russia annexed Crimea. This concern is already reflected in current oil prices.

What will happen to oil prices going forward?

We can divide this into short-term and long-term perspectives. In the short term, prices are expected to rise in the first half of the year and stabilize in the second half. Current oil prices are based on the assumption of an excess demand of about 4 million barrels per day. Russia produces about 11 million barrels per day, and it is assumed that production will decrease by about 40% due to conflict and sanctions. In an extreme case where all pipelines from Russia to Europe are blocked and natural gas must be entirely replaced by crude oil, Europe would need an additional 3 million barrels of oil per day. This figure is slightly smaller than the market forecast of about 4 million barrels of production disruption due to the Ukraine crisis. Since excess demand is excessively reflected in prices, even if conflict occurs in Ukraine, the impact on oil prices may not be significant.

After this phase, oil prices are likely to stabilize in the second half of the year. In the third quarter, OPEC+ production cuts will end, and US oil production will recover, increasing downward pressure on prices. Although a political event, progress in Iran's nuclear negotiations is also a factor that will help stabilize oil prices going forward.

The problem lies in the long-term outlook. The international oil market has structural instability factors, so prices can change rapidly at any time. To prevent this, structural changes in demand and supply are necessary, but the foundation has not yet been established.

The oil market stabilized after prices exceeded $100 per barrel in 2011 thanks to shale oil. Shale oil partially replaced conventional crude oil, causing oversupply in the oil market. In 2011 and 2012, US shale oil production increased by 55% and 66%, respectively, so that by 2012, shale oil production was 2.6 times that of 2010. The emergence of shale oil as a substitute created a foundation to break the OPEC+ resource cartel, and that power pushed oil prices down.

On the demand side, the slowdown in demand from emerging countries that led the commodity supercycle in the 2000s pulled oil prices down. Since China entered double-digit growth in 1995, this trend continued for more than 15 years until 2011, during which raw material demand surged. It was not only China; many emerging countries such as India, Russia, and Brazil experienced similar situations. This rapid increase in raw material demand began to decline after peaking in 2011. China's crude oil imports, which grew at an average annual rate of 13.1% from 2001 to 2011, slowed to 9.1% from 2012 to 2019. As high growth ended and transitioned to a middle stage, raw material demand decreased accordingly.

Currently, there are no factors to change the structure of the oil market. There are no means to increase supply, and a dramatic decrease in demand is unlikely. However, oil prices approaching $100 per barrel are prices that neither suppliers nor consumers want, so it is possible that a balanced price will form at a lower level than now. Since raw materials are goods used in the real economy, demand and supply are important. Once balance is achieved, that price tends to persist for a long time. Many professional institutions forecast that a balanced price will form in the $80 range.

This content was produced with the assistance of AI translation services.