Don’t Bet On President Biden’s Promises That Oil Prices Will Drop

President Joe Biden’s administration expects gasoline prices will continue to fall toward $4 a gallon, but most market watchers disagree.

Oil prices were back on the rise Monday on supply fears, with benchmark Brent crude back comfortably over $100 at $103 a barrel.

Average U.S. retail gasoline prices have fallen nearly 50¢ a gallon to $4.65 a gallon since peaking above $5 in June. Still, there are ample reasons to believe that the current energy crisis will persist and that prices are poised to push higher again.

Oil and gasoline prices have been falling recently because of mounting fears of economic recession, which would reduce fuel demand.

But despite record-high prices, U.S. gasoline demand is running only 4-5% below pre-Covid levels for this time of year. In other words, demand erosion has not been dramatic as most consumers’ desire to resume their post-pandemic travel habits has trumped the pain of higher costs at the pump.

So, while oil demand may ease due to an economic downturn, it probably won’t drop as severely as it may have in previous down cycles. Indeed, the biggest wild card here is China’s continued “zero Covid” policy, which threatens more lockdowns in the global oil market’s biggest growth driver.

On the supply side, there are a few reasons for optimism.

OPEC+ has limited spare production capacity, perhaps 2 million barrels a day – which is scant in a 100 million barrel-a-day global oil market. Most of this resides in Saudi Arabia and the United Arab Emirates. Saudi Crown Prince Mohammed bin Salman made it clear over the weekend that he would not bail out Biden by producing more oil despite the administration’s repeated pleas.

It’s anyone’s guess how OPEC+ will behave after its current supply deal ends in September, but it’s clear that the group’s capacity to produce more is almost non-existent outside the Mideast Gulf. OPEC+ is now producing more than 3 million barrels a day below targeted levels due to various technical, operational, geopolitical, and investment issues in weaker member states like Nigeria, Angola, Kazakhstan, Ecuador, and Malaysia.

Then there is Russia. So far, Russian production and exports have been remarkably resilient in the face of Western sanctions and other (unsuccessful) efforts to reduce the flow of petrodollars to Moscow after its Feb. 24 invasion of Ukraine.

But there is no guarantee that Russian output won’t still buckle. The International Energy Agency thinks that Russian production “losses could expand to around 3 million barrels a day in the second half of the year.”

That’s because the EU recently agreed to phase out imports of Russian oil by year-end with some exceptions. That difficult work will happen in the coming months, placing greater pressure on Moscow to find alternative markets.

China and India have been lapping up discounted Russian barrels, but they can only take so much Russian oil because they don’t want to break long-term supply contracts with Mideast suppliers. Diversity – and thus security – of supply remains paramount to these massive energy importers. They have almost maxed out on Russian imports.

U.S. shale oil production is growing rapidly and will deliver additional critical supplies in the balance of this year. Some think U.S. oil production could exit 2022 about 1 million barrels a day higher than where it started, pushing it to around 12.8 million barrels a day.

That is a dramatic increase – but it will come as huge, unprecedented releases from the U.S. Strategic Petroleum Reserve (SPR) end this fall. This will remove 1 million barrels daily from global markets, leaving the Biden administration with no real levers to tamp down prices.

We also can’t forget the shortage in global refinery capacity. The world has closed some 4 million barrels a day of refining capacity since 2019 due to the pandemic-related demand collapse, including 1 million barrels a day in the U.S. The Middle East and Asia are the only regions investing in any new capacity. That won’t change – not with Biden and Europe pressing for a faster energy transition to cleaner fuels.

Indeed, the lack of investment across the oil industry has been a long-running theme. Overall, the investments in upstream production and refining projects have declined significantly in recent years. This translates into lower expected production capacity for crude and finished fuels, both from OPEC and non-OPEC.

Because of this, it’s hard not to believe that the main risks for oil prices remain tilted towards the upside.