Warnings are multiplying that the oil supply shock caused by the war in the Middle East is going to cause permanent changes in demand patterns. The longer the war continues, the higher the chances are of those changes materializing as lost barrels pile up.
There is up to 1 billion barrels of oil in lost supply, “all but guaranteed”, Bloomberg reported last week, noting that demand is already being destroyed in Asia. Yet the destruction is spreading across the world slowly and quietly, but surely, as governments are about to run out of oil in storage that is being used to blunt the impact of the Middle East supply loss on prices.
“As of today, we’ve lost 13 million barrels per day of oil … and there are major disruptions in vital commodities,” the secretary general of the International Energy Agency, Fatih Birol, told CNBC earlier this month. “We are facing the biggest energy security threat in history,” Birol also said, which he later repeated in an interview with The Guardian, scolding governments around the world for making their economies dependent on hydrocarbons. Birol has been a vocal supporter of a transition from oil and gas to wind and solar.
The transition argument has benefited significantly from the oil crisis, as expressed by the IEA’s Birol to The Guardian. “Their perception of risk and reliability will change. Governments will review their energy strategies. There will be a significant boost to renewables and nuclear power and a further shift towards a more electrified future,” he told the publication, noting this would result in oil demand loss that will be permanent. Related: BP Shares Up 20% Since Iran War, Leading All Supermajors
Many are skeptical of such a development; however, the sheer size of supply loss suggests that oil importers will do whatever it takes to avoid supply crunches, including building more wind and solar, despite their shortcomings that have kept them a minor part of global primary energy supply, still dominated by hydrocarbons, including coal.
Coal, by the way, is the other big winner from the crisis alongside alternative electricity sources. In a rather ironic twist, energy importers finding themselves unable to afford continued LNG purchases at a higher price than Qatari gas have turned to coal instead. Coal is cheap, much more widely available than liquefied gas, and abundant.
Developed economies like Japan and South Korea are raising the use of coal-fired power generation, while developing nations, China, India, Bangladesh, and most of Southeast Asia are leaning even more on coal as gas has become scarce and much more expensive.
This switch to coal is going to affect primarily gas demand and, more specifically, LNG demand. As for crude oil, the supply shock may very well lead to greater interest in electrified transport, and this has the potential to change long-term demand patterns, indeed, but only hypothetically—because electricity prices as well as EV prices also depend on hydrocarbon prices.
Analysts have reported that the supply crunch in oil is hitting the petrochemicals industry hard. A lot of industries depend on petrochemicals for their own products, and EVs, wind and solar power are among them. If prices rise for crude, they rise along the supply chain for everything from electric cars to cables, ultimately making the alternative to hydrocarbons more expensive as well and thereby killing demand for energy overall.
“Because there is still no visible disaster” in the west, “people think everything is okay, and a bit higher pump prices are the only impact,” the head of energy transition at FGE NexantECA told Bloomberg. However, demand destruction “will come and is coming in waves. Asia was first in line, and Africa is the next one. Europe has already started talking about the lack of some fuels and feeling the price impact,” Cuneyt Kazokoglu also said.
There is, however, a sort of silver lining. Because if demand destruction is left to the market to decide alone, prices would need to rise much, much higher for this destruction to occur. According to FGE’s Kazokoglu, oil would need to hit $250 per barrel, which echoes warnings made early on in the war by other expert observers.
“We’re very much in the $150 range but I don’t think it’s ridiculous at all to [suggest] $200. It would be very fair given we are basically having a crisis-a-day right now equivalent to supply outages,” Onyx Capital Group CEO Greg Newman said in early March. “I wouldn’t be surprised if oil went to 200 bucks, or even 250, because commodity prices go parabolic when there’s a shortage of supply,” the chief market strategist of Longview Economics, Chris Watling, said at the time.
Currently, Brent crude is trading at a much lower level than that, hovering around $106 at the time of writing. WTI is back below $100 per barrel. Yet these are the futures market prices. Oil for physical delivery can fetch hefty premiums because everything from freight to insurance has become more expensive, just like oil itself. Demand destruction is on the way, no doubt about that. The only question is how severe it would be and whether it would really become permanent.
By Irina Slav for Oilprice.com
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