The price of oil: the short and long term unknown

Jun 13, 2022

Redacción Mapfre

Redacción Mapfre

Following the recent bans announced by the European Union to reduce its energy dependence on Russia, OPEC (Organization of Petroleum Exporting Countries) has responded affirmatively by increasing crude oil production by 648,000 barrels per day for July and August, which would represent a 50% increase on current levels. But the price per barrel remains at over 120 dollars these days. "According to the IEA, the embargo on Russia amounts to 3 million barrels per day less, so OPEC's increase seems negligible to me as a shock measure," says Javier de Berenguer, fund and financial markets analyst at MAPFRE Gestión Patrimonial (MGP).

For the time being, experts anticipate that the new decisions taken to cut 90% of Russian oil purchases by the end of the year (part of the EU’s sixth package of sanctions) would cause Russia to lose around 80 billion euros a year. In fact, Ismael García Puente, investment manager at MGP, states that, following the sanctions imposed as a result of the war in Ukraine, “Russia will no longer be able to contribute to world production” as it once did. Consequently, Brussels will have to counter the energy shortage by formalizing new agreements or relying on OPEC to boost production.

But, this obviously, will have consequences on the economy. As De Berenguer explains, Russia is the second/third petroleum exporter in the world (it alternates in second place with Saudi Arabia). Approximately 9-10% of Russia’s GDP comes from crude oil sales profits. “If the EU purchases more than 35% of Russia’s petroleum and Europe across-the-board adds over 50%, the 2/3 embargo from the EU will cause Russia’s GDP to drop by 2-2.5%. If this would increase to 100% and more European countries would join the cause, the impact on the Russian economy would be devastating, with a GDP setback that could equate to 4-5%,” he adds. “Of course, this doesn’t come without an expense for the EU, since the embargo could cost about 0.5% of the GDP due to pricier raw materials, he comments.

All of these events have led to those higher levels of petroleum (last month, the cost per barrel rose by 20%). Current energy prices have been feeding inflation in recent months (reaching maximum levels in almost three decades), and the secondary effects have already started to show (core CPI is nearly 5% in Spain). The question on the minds of investors and citizens alike is how long oil prices will remain at current levels.

The answer is not straightforward. From Garcia Puente's perspective, there is a twofold analysis in this context: one in the short term and another in the following months and years.

  • In the short term, with the increase in production by the Saudi Arabia-led organization, the price of oil could fall a little,” explains García Puente, although his view differs in part from some investment firms, which predict new spikes in the short term.
  • However, García Puente expresses that “the situation is more concerning” in the medium and long term. “The self-imposed hardship that the European Union has instigated by cutting crude oil imports from Russia will cause the market to tighten. No matter how much they want to import from the US, there will be fewer supplies. Alternative sources remain scarce and will be slow in coming,” the expert adds. The Fitch rating agency’s viewpoint is more pessimistic. It recognizes that prices could soar even higher, aggravated mainly by the difficulty of redirecting all production to the Old Continent. This scenario will fuel the need for new crude oil importers to enter the European commercial chessboard.

Alberto Matellán, the chief economist at MAPFRE Inversión, believes that the concern is not how much the spike may reach but rather the volatility in the price in recent months: “Not having a clear trend to refer to means that policies implemented to improve the situation are more uncertain.” To determine a concrete price, he claims, is very complicated, but he does believe that there is a visible structural problem. On the one hand, he explains that “there is a strong growth in demand,” driven by the removal of restrictions (China’s economic reopening would boost the global demand for crude oil) or by structural changes that sanction fossil energy. But, conversely, Matellán adds that “there is a decrease in the investment in producing this energy” in favor of other ‘green’ energies.

Other Factors

De Berenguer also adds other factors that would cause prices to remain high: “The low inventories in the OECD countries, the lifting of China’s lockdown (return of demand), Europe’s embargo on Russia (this could, according to the IEA (International Energy Agency), drop world production to 3 million barrels a day) and plus, the summer season. In addition, the IEA expects a rise in demand to about 3.6 million barrels daily due to major air traffic and other types of transportation.”

With that in mind, is it a good time to invest in the energy sector? De Berenguer believes so, mainly because of the current imbalance between the supply and demand of raw materials. But, by fully knowing about the different types of asset exposure, since investing in the ‘commodity’s’ spot price is not the same as doing it through futures. And, of course, contrary to doing it indirectly on oil companies, “which assume other specific risks, sectoral and even the actual idiosyncratic risk of the stock markets.” “If it is finally decided to accept the asset position, it is imperative to learn about the investment as to assume the exposure to it. Therefore, we recommend that the investor contact his financial advisor so that they can make the best decision that adjusts to their needs and their risk profile, he adds.

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