The oil market is having some of its roughest weeks in modern history. Brent crude, the international oil benchmark, broke $100 a barrel in February for the first time since 2014, and eventually peaked at $130 a barrel in early March, its highest price since 2008. The price is still swinging between $100 a barrel and $120 a barrel.
What’s going on, exactly? First, the war in Ukraine is only partly to blame for the wild price movements. Second, the shale oil industry, once touted as a new bulwark against price shocks, is not as forthcoming as the market needs. Third, the U.S. efforts to calm the market are being complicated by long-standing oil geopolitics.
It’s not just the war
Russia’s war in Ukraine might seem an obvious explanation for recent price hikes. After all, Russia is the world’s third-largest oil producer and largest oil exporter. Western sanctions after Russia’s Feb. 24 invasion of Ukraine hit hard, prompting import bans on Russian oil, foreign oil company business exits and payment complications for those trading Russian oil. Analysts project 3 million barrels a day of Russian crude may be subject to disruption, while oil prices could rise as high as $185 a barrel by year’s end.
But even before Russia’s troop buildup began last year, two things had been steadily driving prices higher following the pandemic-linked price drops in 2020 — rising global demand and the controlled unwinding of the historic production cuts made by Organization of the Petroleum Exporting Countries (OPEC) Plus, the loosely connected association of OPEC and Russia-led non-OPEC producers.
In fact, in mid-January — when a full-scale invasion still seemed unlikely — analysts were warning that oil prices could surpass $100 a barrel if rising demand and disappointing supply continued. It follows that even if the war’s effects on oil prices dissipate, prices will probably continue rising if the market fundamentals remain unchanged.
Foreign companies continue to prop up the Kremlin
How does the market handle surprises?
To mitigate the impact of the supply shocks, countries have turned to existing tools to compensate for the lost barrels: International Energy Agency members agreed to release 60 million barrels; the United States said it would release 180 million barrels, the largest withdrawal in its history.
Here’s the bigger surprise: U.S. shale oil suppliers haven’t jumped in. Three-digit oil prices should signal windfall profits for these companies, whose average break-even prices sit around $50 a barrel. And shale wells can also be commercialized within months, if not weeks. Conventional oil wells, in contrast, require several years to develop. This rapid-response capacity is why analysts have predicted price ceilings as low as $50 to $60 in the shale era.
My research partly explains the slower-than-expected market intervention — the U.S. shale industry consists of small producers. The industry lacks a central authority to coordinate a united supply boost, and suffers from huge variations in production conditions, making a prompt and effective intervention highly unlikely in the short term.
Furthermore, because of the mass bankruptcies that have occurred during the pandemic recession, the U.S. shale industry is reporting shortages of the skilled labor, materials and equipment necessary to boost production, and simultaneously prioritizing buybacks and dividends to shareholders over the drilling of new shale wells. Some increase in output may follow, but for now, the possibility of accelerated drilling and a production increase seems unlikely.
Russia’s been hit by a financial Cold War
And we’re back to the old geopolitics
With shale producers not forthcoming, the United States, the world’s largest oil producer, is locked in a game of oil geopolitics, aimed at persuading large traditional foreign producers to pump more oil. Unfortunately, several factors are complicating U.S. efforts to calm the market this way.
My forthcoming book chapter argues that first, the earlier shale boom and the covid-19 pandemic had the unexpected consequence of galvanizing OPEC Plus, allowing Russia and Saudi Arabia to shore up oil prices.
To the market’s surprise, OPEC Plus members have mostly stayed in compliance with the organization’s production quotas. That’s a shift from general trends from 1982 through 2009, when OPEC overproduced 96 percent of the time. Having met their initial objective to control prices, OPEC Plus members continue to stick together even with the war in Ukraine and trying to influence prices in their favor.
Second, Saudi Arabia, which historically has tapped into its spare production capacity to help ease the market tightness caused by geopolitical disruptions, has so far refused to act this time. Saudi leaders declined to discuss the energy situation with President Biden on March 8 — and made no promises to boost oil production during British Prime Minister Boris Johnson’s March 15 visit to Riyadh.
The reluctance to increase production may be politically driven, or may be a sign that Saudi Arabia does not have as much spare capacity as it claims. Either way, the world today seems as beholden to Saudi oil policy as it was during the pre-shale era.
Ukraine war has side effects on Middle East geopolitics
And the energy issues are also complicating other U.S. foreign policy priorities. Hopes of reviving the Iranian nuclear deal were dashed at the last minute last month, allegedly because of Russia’s demand for an exemption to the sanctions on its trade with Iran. The nuclear deal would help ease the supply problems by allowing Iranian oil back into the market, but a lower oil price cuts into Russia’s oil revenue and undermines its bargaining leverage against the West.
The oil issues even appeared to prompt a shift in U.S. policy toward Venezuela, where the United States recognizes Juan Guaidó, not Nicolás Maduro, as president. But U.S. officials met with Maduro, not Guaidó, in Caracas last month, the first formal meetings with Venezuela’s socialist regime in years. The United States probably sought to undermine Maduro’s support for Russia — and help secure alternatives to Russian oil.
The Russian war in Ukraine and the reactions of both the oil market and the U.S. government are uncomfortable reminders that oil is a globally traded commodity. Being the world’s leading oil producer and a net exporter doesn’t shield the United States from the geopolitical risks involving foreign oil production. Like it or not, the old game of oil geopolitics — a long-standing interplay between the United States and major oil producers — is here to stay.
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Inwook Kim is assistant professor in the department of political science and diplomacy at Sungkyunkwan University in Seoul. His research focuses on history and geopolitics of oil, politics of alliances, and the Korean Peninsula.