Why do the oil prices matter to the global economy?
Oil prices are strongly influenced by the global economic outlook. Changes in supply and demand and geopolitical tensions cause price fluctuations.
An orderly energy transition can protect against oil price spikes.
Demand for oil plunged in 2020 during the pandemic when lock-downs led the price to fall below zero first time in history due to a major downturn in economic activity.
Oil prices have since risen sharply to nearly $100 per barrel following strong economic recovery post-lock downs. As the economy grows so does the demand for oil. Moreover, rising geopolitical tensions between Russia and Ukraine and in the Middle East are stoking supply fears. This is contributing to rising inflation and concerns about economic recovery.
Oil accounts for approximately 3% of GDP and is one of the most important commodities in the world in other words petroleum products can be found in everything from personal protective equipment, plastics, chemicals and fertilizers through to aspirin, clothing, fuel for transportation and even solar panels.
Booming economic growth driving demand for oil
Two years ago when COVID-19 started, there was a plunge in economic activity and oil demand. Producers were adjusting production levels, but there is only so much one can do without destroying reservoirs or capital. Storage capacity is also limited. Moreover, there was uncertainty about how severe the economic crisis would be and how long it would last. These compounded factors pushed oil prices to very low levels not seen in decades. There was even a short period of time when oil prices went down to minus $40.
Limited oil supply due to long investment cycles and cautious capital allocations
Supply has not been able to fully respond to increased demand. OPEC has been scaling up oil production slowly, but it also has limited spare capacity and is probably cautious not to oversupply the market again. Beyond spare capacity, oil production has very long investment cycles. It can take up to a decade to reach first production from the moment the resources are confirmed. Some unconventional sources can deliver production much faster, but these are limited in scale.
Geopolitical tensions between Russia and Ukraine and increased instability in the Middle East add to oil market nervousness.