Americans flush with stimulus checks and fat savings amassed in the lockdown don’t seem overly worried about what’s amounting to a sizable, stealth hit to their family budgets. It’s the recent jump in gasoline prices to levels not seen since late 2014, during the bad old days when OPEC reigned and crude stood at $100 a barrel-plus. Since the start of 2021, prices at the pump have surged an average of 35% to $3.27 a gallon in September. That’s a leap of one-fifth versus the pre-COVID sticker for all of 2019. Ninety-percent of U.S. households regularly buy gas, and before the virus struck, the families that take to the road were spending around $3000 a year to fill the tanks. Folks returning to their old habits of vacationing and commuting-by-car will be paying as much as $600 a year more a for gas than just eighteen months ago.
So far, the spike isn’t discouraging Americans from getting back on the road, and you don’t hear a lot of complaining about it on social media. The freedom to get out and spend again is so exhilarating that Americans aren’t nearly as bothered by big prices increases on everything from groceries to gas as in past cycles. But the hit to our wallets could sharpen if the world doesn’t get a big new shot of crude oil supply. A prime candidate for furnishing that sorely-needed production is the Islamic Republic of Iran. Hence, the best and perhaps only shot at lowering prices at the pump rests on the U.S. reaching a diplomatic accord that enables our longstanding antagonist in the Middle East to export far more of its oil.
Why are gas prices so high?
Of course, what’s been gradually inflating the cost of gasoline is the recent run-up in the price in its feedstock, crude oil. It’s hard to believe that U.S. benchmark West Texas Intermediate, after cratering to $15 a barrel in April of 2020, only crossed the $50 mark last December. From there, it’s gone on a moonshot, rising to $80.61 at mid-afternoon on October 12. That’s one-third higher than the norm of around $60 that prevailed from late 2014 when U.S. shale production broke OPEC’s grip starting, to the onset of the pandemic. So what explains the new spike?
The reason is three-fold. First, output from U.S. fracking production has dropped sharply from its peak, and is recovering slowly. “We’ve seen a lot less investment in shale,” says Louise Dickson, senior analyst at research firm Rystad Energy. “Investors and shareholders want dividends instead of more investment in capex.” Adds Richard Joswick, head of global oil analytics at S&P Global Platts, “Investors want better returns, not just more barrels out of the ground.” Dickson reckons that shale’s decline has removed “a couple of thousand barrels a day” from the market, a significant reversal in the force that long held OPEC in check. All told, U.S. output, dominated by shale, has fallen from 13 million barrels per day (bpd) in 2019 to 11.6 million. The shale revolution that hammered prices won’t rescue the consumer this time. Rystad expects a modest rebound in domestic output to just 12.5 million barrels by 2023.
Second, natural gas prices are exploding in Europe and Asia. The upshot: industries in those regions are substituting oil for gas for a basic reason––though the former’s expensive, it’s still a lot cheaper than its potential replacement. The switch hasn’t happened in the U.S. because we produce far more gas than we can export, and our domestic prices for the fuel are low versus Europe and Asia. But in the EU, which benefits from far less natural gas production, the cost of one million BTUs has quadrupled to $23 since December. In Asia, prices are 60% higher than in the 2015 to 2019 period. Italian and German manufacturers have shifted en masse from gas to fuel oil. In Asia, heavy industries are swapping to crude oil itself. The massive migration to oil and its products as a replacement for gas is a major force in driving demand and prices higher. Joswick estimates that roughly 500,000 barrels a day that would otherwise boost daily volumes are now powering plants that once ran on natural gas.
The demand equation
The decline in shale and rampage in natural gas prices has greatly strengthened OPEC’s hand. Further aiding the cartel are the deep cuts it enacted in the pandemic––cuts that it’s now gradually easing on a slow, disciplined schedule. Put simply, OPEC’s been feasting because the great recovery is boosting worldwide oil consumption, including a boost from the quick and enthusiastic return of Americans to the roads, faster than the slow, measured pace at which its member nations are opening the spigot.
In early 2020, OPEC+, the group that encompasses the 13 core members plus ten outside allies including Russia and Mexico, was producing about 40 million bpd. But when the pandemic parched the world’s thirst for crude, the group agreed to a gigantic production cut totaling nearly 10 million bpd. The members came pretty close to matching their quotas, producing around 32 million bpd in program’s early months. From the summer of 2020 through July of this year, the OPEC+ gradually raised its output, then in July made a pivotal move. The members pledged to lift production by 400,000 bpd each month, starting in August, and running through September of 2022, a span of 13 months. Now, OPEC+ is running at between at 37 and 38 million bpd; by the end of what’s called “the tapering,” unless the cartel changes course, production will return to the pre-pandemic level of 40 million bpd, or a tad more.
As Joswick notes, global oil inventories have been declining for much of this year, and that drawdown was a major force pushing prices higher. Demand was simply growing faster than OPEC+ was adding to supply. Its power was on vivid display in early October. The price spike caused traders to seriously consider that the group would raise the 400,000 ceiling to restrain the boom that, if it accelerates, could cause a shock to demand and a backlash from the world’s industrialized nations. Instead, the members stuck with the plan. The news that no extra supply is forthcoming pushed prices from $76 the day before the October 4 announcement, to $81 on October 6, a quick gain of 6%.
Today, whether U.S. gas prices hold firm in the $3.30 range, decline, or keep rising depends largely on whether the world’s oil appetite outstrips or lags what are now pre-programmed boosts orchestrated by OPEC+. If the great reopening keeps sends more RVs on camping trips and cars to the shopping malls, and powering plants to make more soda, outdoor decks and appliances, the only thing that can save families from paying even more at the pump may be the most unusual of diplomatic gambits.
The outlook for gas prices
Of course, many unknowables will guide oil prices going forward. A frigid winter in the U.S. and Europe would greatly tighten supplies, and big releases from the strategy reserves in the U.S. and China would restrain prices, at least temporarily. According to Joswick, prices look high versus the current fundamentals. Seasonal demand is softer as the West and much of Asia transitions from summer driving and vacationing to winter heating. “Inventories have stopped falling and are leveling off,” says Joswick. “They could even build a little bit from here. That could hold prices stable through the first quarter.” After that, he predicts, demand will keep growing and the world will need more supply to prevent prices from trending higher.
The potential crunch, he says, could hit towards the second half of 2022. “OPEC would keep increasing supply gradually, and at some point its excess capacity, and hence ability to further increase supply, would diminish,” he says. That swing production would largely be concentrated in just two hands, Saudi Arabia and the UAE. As we get into late-2022, says Joswick, it will harder for OPEC+ to deliver on its goal of an extra 400,000 bpd each month. By that time, the members’ spare capacity will be lessened, while the risk of supply outages elsewhere in the world will remain significant. Storms in the U.S. Gulf Coast, for example, hammered output this year, and the risk of an upheaval in nations such as Nigeria, Lybia and Iraq could further choke supply.
One possible buffer: An agreement between the U.S. and Iran that enables the Persian nation to export more oil. Today, the U.S. is boycotting Iranian oil and sanctioning foreign companies that purchase supplies from Iran, holding the amounts it adds to the global market far below its capacity to produce. Joswick says that Iran could add one million barrels a day to global output. That extra crude could go a long way towards stabilizing prices at or below $80.
It’s a strange predicament when your avowed foe is also important to keeping the gasoline that’s lifeblood for America’s families affordable. Who’d have imagined that reaching a pact with far-off nation we’re constantly feuding with could be a dollars-and-cents, dinner table issue for America’s families?
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