The emergence of the new Omicron variant has ended, at least for the moment, the surge in oil prices that has unfolded over the course of much of this year.
The oil rally had started to look a bit overdone ahead of the discovery of a new strain of Covid-19. But prices crashed in recent days, and the oil market is now once again exhibiting extreme volatility and enormous questions about what happens next.
Omicron crushes oil
Oil prices had already started to come off of seven-year highs reached in late October and early November. For a variety of reasons, the rally had started to reach its limits. Inflation raised questions about the health of the economy and a potential response from the Federal Reserve; the U.S. initiated a sale of oil from the strategic petroleum reserve; and high oil prices themselves started to crimp demand.
But oil markets saw a dramatic day on November 26 after South African officials informed the world about the discovery of the new variant, leading to the plunge in crude prices by more than 13 percent in a single day. It was the largest decline since the very early days of the pandemic. Oil prices have now lost 15 percent in a week.
Oil markets saw a dramatic day on November 26 after South African officials informed the world about the discovery of the new variant, leading to the plunge in crude prices by more than 13 percent in a single day.
“This eradicated in a matter of days all the gains it had accrued since the end of August,” Commerzbank observed in a note to clients on December 1. Only a few weeks ago, WTI was trading in the mid-$80s per barrel; now it is in the mid-$60s.
Goldman Sachs, which has garnered a reputation as unfailingly bullish when it comes to predicting oil prices, has not shied away from its outlook. In a note to clients on November 30, Goldman analysts said that the 15 percent loss over the past week is “excessive repricing.” In a recent analysis, the bank said that a scenario that saw a new variant that his jet fuel demand, combined with an SPR release, would only drag oil prices down by roughly $5 per barrel. Thus, the $10-$15 per barrel selloff is overdone, they say.
The investment bank goes on to add that a faltering of the U.S.-Iran talks could keep Iranian oil off of the market.
More importantly, the bank pointed to the likelihood that OPEC+ would hit the pause button on its scheduled 400,000-barrel per-month increases as soon as this week. Goldman analysts said much remains unclear, but reiterated that “the market has far overshot the likely impact” of Omicron.
Ahead of the meeting, various bank analysts noted that a pause in the production increases was appropriate, especially in light of the fact that many see a supply surplus emerging in early 2022. Reuters reported that the surplus could balloon to as much as 3.8 million barrels per day by March.
“It would not therefore be particularly advisable to expand production by 400,000 barrels per day in January, as originally planned,” Commerzbank wrote in a report. “This would very probably cause oil prices to slide further.”
Eyes on 2022
OPEC+ surprised the market when it decided to stay the course in a brief meeting on December 2. The group is moving ahead with a planned 400,000-barrel-per-day increase for January, although it cautioned that it could alter its plans at any time should market conditions warrant it. Oil prices dropped by another 4.8 percent in early trading hours on Thursday on fears that the decision will add more supply to a market already heading for surplus.
OPEC+ is moving ahead with a planned 400,000-barrel-per-day increase for January, although it cautioned that it could alter its plans at any time should market conditions warrant it.
But the decision could also be interpreted the other way. Moving forward with planned production increases could be a sign that OPEC+ is not overly concerned about the Omicron variant and expects that the panic spreading in the oil market is excessive. If oil demand doesn’t crater, as the pricing selloff suggests, then the production increases are not necessarily ill-advised. Extending that logic, the move by OPEC+ to not make any sudden moves is perhaps a vote of confidence in the global economy. Indeed, after the initial drop in prices Thursday morning, prices quickly rebounded.
If oil demand doesn’t crater, as the pricing selloff suggests, then the production increases are not necessarily ill-advised.
Still, it isn’t clear that oil will quickly head back to the $80s. That could be a problem for oil drillers, who up until now had been mostly holding off on new drilling, but recently showed some signs of loosening the purse strings.
A new analysis from Rystad Energy estimates that the U.S. shale industry could begin to ratchet up spending next year, in response to higher prices. Shale drillers could increase capex by 19 percent from an expected $69.8 billion in 2021 to $83.4 billion in 2022. However, the firm cautioned that “some hesitancy in spending could yet materialize” in wake of the news about Omicron and the selloff in oil.
Oil prices stuck in the $60s is quite a different thing for shale companies than oil in the $80s. But at this point, there is very little clarity on what to expect. Much depends on how disruptive the Omicron variant is over the next few months.