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Fuel for Thought: Energy security omens returning to haunt oil market

Energy security concerns are bubbling beneath the surface as the global oil market seems to be entering into the early stages of recovery from the pandemic.

While OPEC+ can provide the necessary crude as demand recovers in the near term, there may be a lack of firepower from the rest of the oil-producing fraternity further down the line.

But the recent rise in oil prices could be just what the world needs.

Dated Brent, the global physical oil benchmark, has recently been hovering in the low-to-mid $60s/b, having risen more than 50% since demand-led optimism over the COVID-19 vaccine rollout back in November. And oil prices could shift higher again once the market shakes off the latest bout of coronavirus jitters.

S&P Global Platts Analytics predicts oil prices will climb above $70/b around mid-year as improved supply-and-demand fundamentals starting in May lead to substantial stock draws through to August.

While large oil-consuming countries such as India may crank up the volume over their displeasure and many OPEC+ countries may be eager to ditch compliance to their production-cut deal or push to pump more, both consumers and producers alike may want to consider the benefits should oil prices stay in their arguable sweet spot.

While the warning signs over a supply crunch in the coming years are well documented, they have been overshadowed by the pressing needs of consumer economies ravaged by COVID-19 and producer countries crippled by low oil prices. But these very low oil prices along with the energy transition push have accelerated supply concerns.

Spending slowdown

Many analysts have tried to put huge numbers on the likely shortfall in spending on upstream oil projects in the coming years, signaling that even with higher prices driving investment in new projects, there is a long way to go before this spending starts to plug the gap.

Saying that, there is a strong correlation between the average oil price and sanctioned non-OPEC oil projects in recent years. Indeed, there is already evidence of a pickup in approved oil investments, with some deferred projects in 2020 getting their due.

US oil production, noted over recent years for its stellar shale growth and ability to bring on crude at short notice, is unlikely to return to its pre-pandemic peak of 13 million b/d until the middle of the decade, according to Platts Analytics.

But there are glimmers of hope.

While many US oil companies are still in a precarious financial position, low well breakevens and positive cash flow this year are stimulating shale output at current prices.

"Sustained oil prices above $60/b could allow oil companies to respect the pledges that they made in their latest investor strategies to maintain capital discipline, return capital to investors, reducing their debt, but at the same time increasing their investment," Toril Bosoni, the International Energy Agency's head of oil markets division, said in a recent interview with Platts.

Capacity concerns

In the meantime, as OPEC+ starts to raise output to meet growing oil demand, the amount of spare production capacity in the system begins to dwindle.

Platts Analytics sees the amount of crude that can be sustainably produced at short notice halving by September to less than 4 million b/d, with most of that left in the hands of Saudi Arabia.

While global spare capacity has over the past decade averaged close to 2 million b/d, according to Platts Analytics calculations, attacks on Saudi Arabia oil facilities become a bigger risk factor when oil buffers are reduced.

Global spare oil production capacity

OPEC+ may finally take a bigger share of the market given weaker competition and increased demand, but an overreliance on the oil-producing pact with less spare capacity has its own risks.

Middle East geopolitics are notoriously unpredictable, with recent history marked by Iran sanctions, Libya's internal political dispute, disruptions at pivotal waterways such as the Strait of Hormuz and Bab el-Mandeb, and the attack on Saudi Arabia's Abqaiq oil infrastructure.

While the container ship that got stuck in the Suez Canal rattled supply chains more than oil markets, it should serve as a reminder of how vulnerable chokepoints are for tankers to deliver crude and key oil products, especially when oil balances are thinner.

Energy security comes at a price for both the consumer and the producer, as the former looks to diversify crude streams and the latter tries to ensure better returns. Guaranteed stable supply matched with regular demand is in the interest of all parties. Getting it wrong could prove costly.