The impact of the global energy crisis has begun to seep into the oil market as Brent crude rose to a high of around $85.10 per barrel on Friday, a price that seemed unlikely just 18 months ago when the COVID pandemic halted global mobility and crushed demand. Initially, the recovery in oil consumption was supported by road vehicle usage, shipping activity, and the recent rebound in air travel; now, however, it is driven by the energy crisis.
With natural gas trading at nearly $200 per barrel in Europe, analysts agree that global oil demand will increase by another 0.5% as companies rush to secure any available fuel that can serve as a substitute, ranging from diesel to fuel oil to crude oil. This shift may appear limited to external observers, but in practical terms, it represents a significant change, surpassing the monthly production increases that the Organization of the Petroleum Exporting Countries (OPEC) and its allies aim to introduce to the market, after having already consumed part of their oil reserves.
Gary Ross, a veteran oil consultant turned hedge fund manager at Black Gold Investors LLC, stated, "The broader energy problem makes things worse, as you have to resort to alternatives, in addition to the seasonal increases in demand. This is a very dangerous situation." Oil refineries are reaping profits akin to those achieved since the pandemic began. Gasoline margins in the U.S. are rising, despite typically falling at this time of year. In Europe, diesel profits have reached their highest level since March 2020, while propane and low-sulfur fuel oil prices have climbed to their highest since 2014.
**Futures Market Strength**
Nowhere is oil's strength more evident than in the futures curve, which traders use to bet on market firmness. Near-term contract prices are trading at their largest price increase compared to those set years away, closely monitoring the price differentials between the two nearest futures contracts for Brent crude scheduled for December delivery. The price differentials for both Brent crude and European diesel have reached their strongest levels since 2013. This pattern, known in industry terms as "contango," indicates relative supply scarcity. Signs of strength in the futures market reflect what most analysts predict on paper—a supply demand mismatch of about one million barrels per day in the fourth quarter.
**Energy Issues**
Certainly, the energy crisis isn't the sole upward force causing an increase in oil demand. The escalating crisis in China and other countries with large heavy industry sectors threatens a decline in industrial production and slow economic growth while imposing restrictions on fuel use. China has already announced it will allow energy prices to rise, lifting price caps for energy-intensive companies. A large group of Wall Street banks has already slashed their economic growth forecasts for 2021 for the world's largest oil-importing nation.
In Europe, everything from zinc smelters to carbon dioxide plants has been forced to sometimes cut output, which may diminish the impact of the shift from gas to oil. Torell Busoni, head of the oil markets division at the International Energy Agency, stated in an interview with Bloomberg TV, "Many energy-intensive industries have been forced to halt or reduce their activities due to high energy costs," highlighting the risks to oil demand.
Nonetheless, oil consumption is currently on the rise. In Europe, strong transportation data reflects in demand figures. Shipments of oil products in Spain last month indicated that gasoline demand was 5% higher than in 2019, while diesel demand was just 0.5% lower, according to the operator of the pipeline, Exolum. The International Energy Agency reported this week that global gasoline demand has now decreased by only 2% compared to pre-pandemic levels.
**Aviation Recovery**
Even the aviation sector has shown signs of recovery, with air traffic in Europe returning to three-quarters of its normal levels, up from nearly half of that recovery in June. Airlines from United Airlines to EasyJet are boosting capacity after the relaxation of travel rules in the U.S. and Europe’s vaccination program, which has kept infection rates low.
The rising demand for the transition from gas to oil is also apparent in the physical market, where actual barrels of oil are bought and sold. Sokol oil, a diesel-rich crude from eastern Russia, is trading at its strongest level in 21 months. In the North Sea market, which helps set the global benchmark price for crude oil, differentials have strengthened over the past week as traders indicated increased demand from European refineries and decreased cargo shipments in November.
With the recovery now widespread, refining companies such as Repsol SA, OMV AG, and Royal Dutch Shell Plc reported stronger profit margins in the third quarter, boosting their incentive to process more crude oil. Global crude inventories, including onshore stocks and oil stored on the water (which includes floating storage and transit stocks), are now below pre-pandemic levels, according to the latest data from Kayrros.
**Declining Stockpiles**
This, in turn, is helping drive crude oil inventories down. Kayrros states that global crude stocks, including land stocks, transits, and floating storage, are now below pre-pandemic levels. While U.S. crude stocks nationwide increased last week, inventories at the Cushing, Oklahoma storage hub fell the most since June, leading to a volatile week of derivative trading.
Even as prices approach $85, speculators remain relatively uninterested in oil and are instead more engaged in gas markets, according to Energy Aspects Ltd this week. The consultancy added that speculation is about $35 billion less than during the last time Brent crude reached this level in 2018, meaning that unlike the last time, a sharp price decline does not appear imminent.
Analysts Amrita Sen and Kate Hines wrote in a client note, "With a global inventory decline, refinery margins rising, and gradually diminishing spare capacity, only a drop in demand could halt crude oil prices from rising through the winter."
