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How high could oil prices go? The Strait of Hormuz — through which a fifth of global oil and liquefied natural gas usually transits — is still shut, and the financial world is trying to work out what it means for energy prices. But such estimates are heavily dependent on how long the strait might remain closed and how spooked investors are going to get, which turns the whole thing into an elaborate game of “pin the tail on the donkey”.
That involves, of course, sizing up the donkey. Imagine the worst case, where the strait remains closed for an extended period. That would lop off 20mn barrels a day of crude and refined products from global supply. Even then, some could be rerouted via pipelines in the region. The world was already expected to produce more barrels than it would consume this year, and another few could be squeezed out of other producers — including US shale oil and new hotspots such as Guyana. A net loss of 12mn b/d would be more than oil demand fell during the pandemic.
Thankfully, that’s an extremely improbable outcome. The strait is unlikely to be shut for a lengthy period — whether because hostilities cease or because the US Navy eventually escorts ships. And, amid looming geopolitical clouds, the world has amassed stockpiles of about 8bn barrels of oil and refined products, according to Goldman Sachs. The holders of those reserves could cushion the impact but can’t be relied on to offset the whole thing.
A 2mn barrel-a-day shortfall — equivalent to about 2 per cent of global consumption — is therefore not beyond the realm of possibility, even if the worst does not occur. Escorting tankers through the strait, for instance, might slow the rate at which they can transit. And, in a volatile region, it isn’t hard to imagine partial disruptions or periodic shut-ins of oilfields, resulting in supply that remains below what was previously considered the baseline.
How high does the oil price go in that case? Pretty high, potentially. Demand for oil is inelastic, meaning it’s hard to get people to stop using it, even when it costs them more. The impact on demand would vary widely from place to place and person to person. Airlines usually pass the cost straight through to flyers. American motorists, whose fuel rises in lockstep with oil, tend to be more sensitive.
Look, then, at the last time high oil prices were followed by a 2 per cent fall in consumption, as a guide to how the market rebalances. As Stifel analysts point out, that was between 2007 and 2009. It is an imperfect parallel. On the one hand, the global financial crisis will have made demand more fragile, contributing to the fall. On the other, the oil price had risen gradually, making it easier for the world to adapt, and the global economy had been growing more strongly.
Still, the peak oil price reached was $147 per barrel, equivalent to $222 in today’s money. Again, for that to happen, much has to go wrong. But by that yardstick, even the most bearish estimates out there look sanguine.
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