Last week Brent crude briefly hit $90 a barrel for the first time in years. The latest rise is due to tensions around Ukraine, but energy analyst Irina Slav believes it is the shortest-lived factor in the rise in oil prices. The bigger reason has to do with fundamentals, and Brent crude at $90 a barrel may be just the beginning.

Insufficient spare capacity

OPEC's spare capacity is declining for several reasons, the main of which is underinvestment. As a result, JPMorgan Chase & Co warned in January that Brent crude could rise to $125a barrel as OPEC's spare capacity would fall to 4 per cent of total capacity in the fourth quarter of 2022.

The International Energy Agency (IEA) is more pessimistic, predicting that OPEC's spare capacity could halve to just 2.6 million barrels a day in the second half of the year. IEA says:

If demand continues to grow strongly or supply is disappointing, low inventory levels and shrinking spare capacity mean that the oil market could usher in another volatile year in 2022. "

However, it is not just OPEC. The largest non-OPEC oil producer and the world's largest oil producer, the United States, is reducing production. Shareholders are under increasing pressure on US-listed oil majors to focus on green operations rather than looking for more oil and gas to exploit. As a result, the amount of oil produced in the United States is below its capacity. A report by Morgan Stanley reads:

"the oil market is moving in the direction of low inventory, low spare capacity and low investment at the same time. "

So, according to Irina, this phase seems to be ready for a new year of high oil prices. In the current situation, the $90 price of Brent crude may be just the beginning.

Physical demand is robust

In fact, the consensus on Wall Street seems to be that, in addition to these reasons, the break-even cost of crude oil is also rising because of inflationary trends and labour shortages, which will push Brent crude to $100 in the summer. However, the biggest driver of prices will still be physical demand.

In its latest oil market report, the International Energy Agency acknowledged that physical oil demand had proved stronger than previously expected. Based on this surprising shift, IEA raised its oil demand forecast for 2022 by 200000 b / d. Irina points out that based on IEA's past forecasts, IEA is likely to underestimate the robustness of demand again. Even according to this estimate, oil demand will not only return to pre-epidemic levels, but will also reach a higher level of 99.7 million barrels per day.

The impact of physical demand has affected the crude oil futures market, with the spot premium of Brent crude (the futures spread between M2murM1310 for delivery in two months and delivery in 13 months) rising to its highest level in eight years, a bullish signal for crude oil bullish in the futures market.

Separately, fund managers' net long positions in WTI crude oil futures have risen to their highest level since the end of 2017, with long positions almost 13 times more than short positions, according to CFTC data as of January 25, suggesting traders are betting that crude oil inventories will remain tight in the coming quarter.

In this case, the rise in oil prices is almost certain, as there is little to solve these problems except for another highly unlikely round of blockades. So the question becomes, how high can oil prices rise before they start to fall?

Irina believes that there is still a lot of room for oil prices to rise. In terms of supply, US listed oil companies are still subject to shareholder restrictions. Of course, as oil prices continue to rise, private oil companies will drill, while OPEC will also drill, but may choose to keep production under control. instead of turning to random production, this is mainly because only a few OPEC members actually have spare capacity to increase production.

From the point of view of demandFor a commodity, high prices often hinder consumption. But the problem is that when prices rise too high, goods must have a viable alternative to stop consumption. Judging from Europe's energy crisis this year, there are no viable alternatives to fossil fuels. This basically means that the impact of high oil prices on demand will be slowly apparent, slowly driving down prices.

As a result, this will lead to higher oil prices and higher inflation, and the real impact of high oil prices may only be beginning to be felt.