Will Oil Price Continue to Rise

Get Ready for $150 a Barrel Oil Soon

Despite emergency measures, there's little chance of a price drop.

By , a postdoctoral fellow at the Jackson Institute for Global Affairs at Yale University.

A man stands holding a tool over an oil pumping unit.

June 8, 2022, 4:28 PM

In the wake of the COVID-19 pandemic and Russia's invasion of Ukraine, the world faces a historic energy crunch. Gas prices in the United States hover at $5 per gallon, while energy costs in Europe remain prohibitively high. The Biden administration has pulled out all the stops, releasing oil from the Strategic Petroleum Reserve and pleading with Saudi Arabia to increase production. In early June, Riyadh relented and announced it would boost output in July and August.

But this is cold comfort to consumers. The price of oil has not declined. In fact, it will likely rise, topping $150 per barrel by the end of September—a price that hasn't been seen since 2008. Short of imposing an economic recession or mandating major cuts to consumption through a pandemic-style lockdown, there is little the Biden administration can do to avoid the coming price shock. There are four reasons for this.

The first reason is very basic: Despite oil prices rising, the consumption of oil products does not seem to be falling. In fact, consumption has held steady in 2022 in the United States in the wake of Russia's invasion of Ukraine in late February. While consumer confidence is low, Americans are buying goods in large quantities. Economic growth and jobs growth remain fairly buoyant, talk of "stagflation" and an imminent recession notwithstanding. The months of July-August typically see a spike in the consumption of transportation fuels such as gasoline and diesel in the United States, as more Americans take to the road for vacations or day trips during the warm-weather months.

Other major economies are also experiencing surging demand. After several weeks of COVID-19 lockdowns in critical cities such as Shanghai, the Chinese economy is coming back to life, though fuel imports have been lower due to the nation's well-stocked inventories. Gasoline consumption in the European Union remains below pre-COVID-19 levels and will likely stay down due to the group's efforts to cut all imports of Russian oil. Nevertheless, demand remains strong outside the United States as well as within it and will likely rise, particularly in China, throughout the next few months.

The second reason is more complicated and connects to the ways crude oil is manufactured into usable oil products. There are many varieties of oil, and all crude must pass through a refinery and undergo specific chemical processes before being of any use to consumers. A refinery cannot make gasoline or diesel as if by magic; it takes time and effort, and each refinery is designed to produce specific products in specific quantities. Changes to refinery throughput are expensive and time-consuming.

The COVID-19 pandemic witnessed a decline in global refining capacity, as multiple refineries in the United States and Europe were shuttered. Some facilities were shut down in response to the pandemic, but oil companies in late 2019 were already eyeing declines in refinery capacity due to squeezed margins and uncertain future demand. Before COVID-19 hit, the industry faced what was described as a "peak oil demand" linked to slowing economic growth, rising electric vehicle adoption, and a general push toward net-zero greenhouse gas emission commitments. Companies have not committed to building new refineries, as the risk of future declines in demand do not justify the capital expenditure. As a result, the current consumption boom has demand for products outrunning refining capacity, both for gasoline and diesel, and refineries in the United States are operating at 93 percent of their total capacity.

While nations and companies can draw from inventories of oil and oil products stored for future use—one innovation of the 1970s energy crisis that continues to shape energy economics today—those inventories are being exhausted at a historically rapid pace. This is the third reason why prices will continue to rise.

Futures traders and others who speculate on oil prices watch inventory draws—the amount of oil that is either entering or leaving a storage facility at any given time—very closely. Sharp declines in inventories suggest high demand will continue even as consumption relaxes, as companies will have to keep buying oil to refill their inventories. This includes the U.S. Strategic Petroleum Reserve, from which the Biden administration plans to release 260 million barrels between October 2021 and this October. The reserve will be refilled this fall, placing upward pressure on prices as the market locks in the additional demand.

This brings us to the fourth reason: supply. Under normal circumstances, producers would respond to higher levels of demand by pumping more oil. But there is a shockingly small amount of spare capacity left in the global oil economy.

The United States, the world's largest oil producer, will increase production by as much as 720,000 barrels per day in 2022. Investors have been slow to pump more money into new production, yet despite their hesitation, domestic output is on track to break records in 2023. Material constraints, such as a lack of pipelines and labor needed to tap new wells, make an additional increase in output unlikely.

OPEC, led by Saudi Arabia, has less than 2 million bpd in spare capacity. The group recently announced an increase of around 600,000 bpd in July and August, but experts do not expect OPEC to achieve that level, owing to current difficulties in many member states with hitting quotas.

Of greater importance is the supply shock of Western sanctions on Russia, which include EU and U.S. bans on imports of Russian oil. The U.S. Energy Information Administration estimates that 2 million bpd will be lost as Russia winds down production—a greater amount than new production in the United States and OPEC can cover.

The Biden administration has done what it can to allay high gas prices. But its policies are constrained by political realities. Advocating for cuts in consumption—announcing "gas-free Sundays," as U.S. officials did during the 1970s energy crisis, for example—are unattractive and appear defeatist, leaving an already unpopular president to additional attacks from Republicans. Instead, President Joe Biden's White House has subsidized consumption in the short term while accelerating the development of energy alternatives, such as electric vehicles and heat pumps, that will reduce fossil fuel demand in the future.

The full effect of such policies will take some time to be felt. In the meantime, oil prices will rise, for the four reasons listed above. It remains an open question as to how much, but a reasonable estimate puts the ceiling at between $130-150 per barrel. Above that level, demand destruction will set in as consumption becomes too expensive to maintain. The last time this happened was in mid-2008—a collapse in demand that accompanied a global financial crisis of historic proportions.

Here's hoping events turn out differently this time around.

Gregory Brew is a postdoctoral fellow at the Jackson Institute for Global Affairs at Yale University. He is a historian of oil, the Cold War, modern Iran, and the Middle East. Twitter: @gbrew24