Asia is home to 60 percent of the global population and is the largest consumer of total primary energy, oil, coal, and renewables. It is also the third-largest natural gas consumer behind Europe and North America. As more natural gas becomes available in the form of LNG and piped gas, the region will soon become the world’s largest consumer of natural gas as well. Despite being the world’s largest consumer of oil, the Asia Pacific region only holds 2.8 percent of global oil reserves and only produces 7.63 million barrels per day (mmbd) compared to its oil consumption of 35.8 mmbd. That is an enormous amount of oil it has to import on a daily basis.
Asia’s High Oil Import Dependency and the Strait of Hormuz
In 2018, over 78 percent of Asia-Pacific oil demand – 28.17 mmbd – was imported. Of those imports 20.7 mmbd, or over 73 percent of regional oil demand, transited through the Strait of Hormuz – a very narrow ally connecting the Persian Gulf with the Arabian Sea and a critical route for global energy security and international trade (Figure-1). This small ally is about 21 miles wide at its narrowest point and due to depth restrictions is only about two miles wide in each direction for tankers. This supply chain is the backbone of Asia’s economic prosperity – China, Japan, India, South Korea, Singapore and Taiwan are just a few of the countries that rely heavily on this strait. It is also the major supply route for oil and gas exports to Asia from the Gulf. Any disruption in the Strait of Hormuz, a major chokepoint for oil and trade, can lead to substantial supply delays would shift market sentiment dramatically. While there are alternative routes, they are significantly longer and more expensive. A disruption in this area could also expose oil tankers to theft from pirates, terrorist attacks, political unrest (in the form of wars or hostilities), and shipping accidents that can lead to oil spills.
Three scenarios that could send oil prices higher
Out of the many possible scenarios that market observers must consider, the three listed below are the most likely to send oil prices higher. The first is based on market fundamentals, the second on natural disaster, and the third on human intervention.
It is now obvious that global oil demand is significantly lower than supply. Even the OPEC+ agreement to cut 10 mmbd wasn’t enough to balance markets. As long as supply remains significantly higher than demand, prices will remain in the twenties or even lower. In order to bring the market back into equilibrium – oil production has to fall substantially, or demand must begin to bounce back.
If OPEC+ and other non-OPEC actors including US shale oil producers decide to cut oil production in the range of 20-25 mmbd for a couple of months or until the surplus is exhausted, then oil prices should recover. These sweeping production cuts would be good for the entire oil industry. A cut of this size would see prices move back into the $30 to $50/bbl range in a relatively short period of time.
If, however, other oil producers are hesitant to take part in a second OPEC+ cut, we will likely see the cartel remain with its existing strategy of a 10 mmbd production cut. The world will continue to experience a surplus of oil supply and low prices will persist until the market finds its new equilibrium. As global storage reaches capacity we will see unplanned shut-downs which will hurt the oil industry at large and shale producers in particular. Many smaller producers will be forced to shut down temporarily while others will go out of business. Oil prices will remain low for an extended period of time as the world waits for global oil demand to return and the impact of the COVID-19 pandemic to fade.
The second possible scenario is that COVID-19 hits the supply chain directly – namely at an oil production site or refinery – partially halting production and refining operations. This kind of dramatic event would instantly increase oil prices into the thirties. If this outbreak persists for weeks, it will eventually send oil prices to over $40/bbl irrespective of surplus. Nevertheless, such an increase will only be short-lived as demand would remain depressed and eventually production would come back online.
Back in September 2019, Saudi Aramco oil facilities were attacked – disrupting a significant amount of oil. These attacks led to relatively large daily price change and lots of intra-day trading volatility. In light of this attack and many similar ones in the past, the third possible scenario is human intervention. If Iran overreacts to recent tension in the Gulf and closes the Strait of Hormuz to hurt Gulf oil exporters, for example, the impact on the oil market would be very noticeable.
Iran is unlikely to escalate tensions to the point where it closes of the Strait of Hormuz as it would severely damages its own economy with such a move. In the extreme scenario that this does happen however, it will be considered a direct challenge to the U.S. This may lead to further escalation in the Gulf and could even lead to a proxy conflict. In this scenario, oil prices would bounce back above the thirties and could even reach above $50 per barrel.
All three of the above scenarios will lead to an increase in oil prices as the market is forced to quickly adapt to a new supply-demand dynamic. The time scale of each scenario varies depending first upon the sentimental impact and then upon how quickly it can bring global supply back into balance with demand. Scenarios 2 and 3 will be short-lived as they fail to solve the fundamental problem of a surplus in supply. The option of a coordinated effort between all oil producers appears to be the optimum solution for those looking to increase oil prices to $30 and beyond. Such coordinated efforts would also save the oil industry from further demolition.