Cebr Chief Energy Adviser Mike McWilliams is a leading energy expert and he has a model of the factors that drive the energy economy which we use. After a week when energy traders have been warning of oil at $200 a barrel (though they are hardly independent commentators!) we have run various scenarios on the model to get an understanding of the relevant dynamics in a world with one of the leading producers, Russia, being sanctioned.
The oil and gas markets are very different. Oil is an international market and the commodity is very transportable. This means that as long as large purchasers around the world continue to buy, sanctions in the West on purchasing oil from Russia can only have a limited effect because the Russians can sell, if typically at a discount, elsewhere. What could and almost certainly will have an effect is that production in many other places can be stepped up over a period of a few months, strategic stockpiles can be released and high prices can affect demand. All of these factors should work to bring the price of oil down by the end of the year.
The average energy intensity of a unit amount of GDP has gradually fallen from its peak in 1973 and is now only 40% of its level then1. This has cushioned the blow to world GDP from high energy prices. But it’s important to note that although the dependence has fallen, there is still a relationship. Interestingly the decline since 1973 has been almost exactly a straight line – something that is rarely observed in economics. This hints that technical trends and the shift in GDP from goods to services may play a bigger role than short term price fluctuations. We expect demand for oil to fall as a result of both the direct impact of higher prices and also the impact of weaker GDP growth. We forecast that the US State Department can pressure Middle East producers to increase supply by around 1.5 million barrels per day. The Baker Hughes rig count this week had risen to 670, not far off the pre-pandemic level, suggesting some recovery in US domestic supply as well.
It’s hard to see the current price of oil being sustained for long given all the factors at play that should bring it down. The forward market for oil is predicting Brent crude below $90 in 2024 against this morning’s (31 March) spot price of $107.60. Moreover, much of that fall is forecast by December 2022. Our model’s central results are very close to that predicted by the forward market.
The gas market is more regional and gas is much more difficult to trade with the need for specialised terminals both to load and to unload, though LNG shipments are likely to increase. European prices tend to be equalised by interconnectors.
Many parts of Europe, especially Eastern Europe, Austria Germany and Italy, are very dependent on supply from Russia. There is potentially a crunch coming since Russia has announced that it will only accept payments in rubles for gas from 1 April. Germany has said it will rather face recession than pay in rubles and has prepared for gas rationing. It has also announced that it will build two LNG terminals and Shell has already booked space on the first one, which is being expedited.
But until terminals are built and operating and demand is reduced, Europe has to chose between facing a recession and continuing to buy Russian gas. In all probability there will be a bit of both.
So there is some hope for early relief at the petrol stations. But the cost of heating your house on gas may well stay up for years rather than months. We expect on most scenarios that in five years’ time prices of both oil and gas will be noticeably lower than today. But developments after that will depend much more on the scale of progress to net zero than simply on the impact of sanctions.
1 ‘Oil Intensity: The curious relationship between oil and GDP’ Christof Rühl and Tit Erker Harvard Kennedy School M-RCBG Associate Working Paper Series No. 164 May 2021
For more information please contact:
Douglas McWilliams, Deputy Chairman Email email@example.com Phone 07710 083652
Mike McWilliams, Chief Energy Adviser Email firstname.lastname@example.org Phone 07941 302972