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High oil prices threaten already fragile global energy markets

After suffering low oil demand last year due to the COVID-19 pandemic, global energy markets are now facing another crisis, with energy prices reaching record highs and global oil prices doubling year-on-year as demand rebounded from historic lows, but supply has shown signs of lagging.

The global economy is expected to post record growth of 6% this year after contracting by 3.2% last year. Production has also jumped in many industrial sectors after oil demand recovered from the pandemic.

The use of energy and raw materials has also increased. However, markets have been so focused on reduced demand that only now do they feel the lagging production capacity.

Further contributing to a perfect storm, energy consumption saw never-before-seen increases, due to exceptionally cold weather last winter followed by an exceptionally hot summer, which caused a supply deficit and triggered a rapid rise in energy prices. Since last year, natural gas prices have increased by 150% in the US and by more than 600% in Europe.

The crisis caused by this energy supply deficit has spread, not only geographically, but also across different energy industries. The rising cost of natural gas has forced producers in all sectors to seek alternative energy sources, including coal and oil, despite the high carbon emission taxes associated with them. The cost of producing electricity from coal has increased, as producers must pay higher taxes on the greenhouse gasses they emit.

Creating a domino effect, this has caused electricity prices to reach record highs, first in Europe and then throughout other regions of the world.

Record-high electricity and natural gas prices have not only impacted fuel-intensive industry production, but also oil prices. The oil market is now experiencing the reverse of what it did last year, when a supply glut coupled with low demand pushed oil prices below $20 a barrel.

Just as the global economy recovered after the easing of COVID-19 restrictions and oil demand and prices returned to pre-pandemic levels (even hitting a three-year high in September), markets are now facing yet another crisis – this time due to falling supply.

Supply concerns intensified after oil production in the US, the world's largest oil-producing country, was disrupted by hurricanes that hit the country’s southern coast in August. Concerns were exacerbated even further by underinvestment and ongoing technical problems in certain oil-producing countries, including Nigeria and Angola.

In September 2020, the per-barrel price of Brent oil reached a low of $39.30 and a high of $46.22. In September of this year, it traded at a low of $70.42, before rising to $80.75 – the highest level seen since October of 2018.

The International Energy Agency estimated that the global oil demand will reach 96.15 million barrels per day (bpd) in 2021 and 99.39 million bpd in 2022 on the back of the post-pandemic economic recovery after declining down to 90.91 million bpd last year due to COVID-19 pandemic.

The global oil supply is also estimated to reach 95.35 million bpd in 2021 and 101.65 million bpd next year after last year’s pandemic-induced lows of 93.87 million bpd.

If the upcoming winter is cold, the record-high natural gas prices are expected to further raise demand for alternative fuels, forcing electricity companies to shift to using oil for generating power and thus push crude higher.

One of the most influential banks in the commodity markets, Goldman Sachs, last week raised its oil price forecast for this year by $10 per barrel to $90.

Goldman Sachs attributed its price revision to the faster-than-expected recovery in fuel demand following the impacts of the Delta variant of COVID-19 and to the contraction in global supply with the decline in US crude oil stocks.

Also, the Wall Street bank revised up its oil price estimate, lifting its previous US crude oil price of $77 per barrel to $87.

Rising oil prices have also been one of the biggest drivers of inflation as they induce upward movements of fuels like gasoline and diesel and act as a drag on the fragile economic recovery and oil consumption.

- Dollar-indexed oil imports becoming additional burden for Turkey's economy

Pointing to the significant "base effect" due to the collapse of demand and the following fall in prices after COVID-19 forced a global shutdown of the economy, Julien Mathonniere, an oil markets economist at Energy Intelligence Group, told Anadolu Agency that the crude oil prices took a beating after this unprecedented demand destruction.

After the global mobility was paralyzed due to various impediments and almost all international flights were canceled, the jet fuel demand was crushed, and any demand rebound from that low base in 2021 was likely to have a significant impact on oil prices, according to Mathonniere.

The reflation trade, in which an economic comeback is associated with some level of inflationary pressure on cyclical industries such as construction, commodities, real estate, and services, has become one of the most popular narratives in 2021, he said.

"This tends to push demand and prices higher. And of course, when this happens, as an investor, you want to be ‘long oil’, that is, you want to own the underlying asset [oil] and wait for prices to increase before selling it back at a profit,” he said.

Mathonniere said this tendency applies to most commodities such as grain and metals. "So, demand for oil paper contract [derivatives like oil futures, oil options] is shooting up, and this is partly why we have seen prices rallying so fast."

"This is also why the paper market has overshot the spot market for actual cargoes of crude [refiners buying]. The physical market is still constrained by how good refining margins are, as well as the level of global crude and refined product inventories," he said.

Mathonniere further explained that oil is a good hedge against inflation or the fear of inflation “because if you own oil futures, they increase in value, which partly offsets the effect of higher prices elsewhere --like having to pay more for food or medical services, for example. So, with inflation fears looming larger, funds are increasing their bullish bets in oil to hedge their inflation risk.”


The rising oil prices in global markets are also expected to impact Turkey as dollar-indexed oil imports will create an additional burden on the economy.

Turkey's energy import bill increased by 104% to $4.36 billion in August this year compared to the same month last year, according to data released by the Turkish Statistical Institute last month.

The country's crude oil imports showed a 52% increase compared to August 2020 and reached 2.85 million tons of crude oil in August, up from 1.87 million tons in August 2020.

 

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